Build your own rocket and pilot yourself into space? Why not? It might work. You could wind up having
the time of your life and go down in history if you pull it off. If not, you probably won’t be around to regret
it.
With all due respect to the actual rocket scientists who may be reading this, no matter who you are, the
odds are against you. And, that’s why you wouldn’t do it — you are highly likely to fail. At best, you would
waste your time and hard-earned money. At worst, you would kill or seriously injure yourself or someone
who happens to be in the wrong place at the wrong time. There are so many ways for such a complex
project to go wrong that to succeed you’d need a lot of knowledge and skill plus an amazing amount of
good luck.
Actively managing your own Thrift Saving Plan (TSP) account into and through retirement can be just
about as risky. Sure, you probably won’t kill yourself, but you may unwittingly commit financial suicide
before it’s all over. The activity in the TSP following a drop in the stock markets in February demonstrates
that many TSP participants actively manage their accounts — that is, trade into and out of the available
investment options in an attempt to beat what the funds would deliver, undisturbed, during the period. I
regularly hear from TSP participants who confirm that active account management is their strategy of
choice.
The problem with active investment management is that it’s a loser’s game. By that, I mean the odds are
decidedly against a successful outcome. In spite of the fact that active management probably won’t pay
off and that investors have been told so for many years, hope springs eternal.
Millions of investors continue to struggle against the odds. In the TSP, the odds of successfully beating
the return you could earn holding a properly diversified portfolio of the five funds by selectively trading into
and out of them are especially low. This is because the TSP’s extremely low expenses eat up very little of
that return. Yet, active TSP account managers persist. Here are the facts that make active management
in the TSP a bad idea.
Zero-sum game
Investing in a market is a zero-sum game. The return for a given market, say the 500 stocks in the S&P
500 index, on which the TSP’s C Fund is based, during a given period is the sum of all returns earned by
the various investors in that market during the period — the average return for the group.
Added together, the group of individual investors who participate in the market during that period cannot
earn more than the market’s total return. During any period, some of the investors in the stocks of the
S&P 500 will earn more, and some less, than the average return. For any one investor to earn more, it
must come at the expense of another who earns less. Investing is a “feeding frenzy” over profits. If you’re
going to take more than your share of profits, you’ll have to wrestle them away from someone else.
You’re not that smart
This is hard to do since, no matter how high your IQ may be, you’re not smart enough. How much will you
spend on investment research next year? How many face-to-face meetings will you have with top-level
managers from public companies? How many Ivy League graduates do you have working long hours to
further your cause?
Not enough. It pays to realize that you’re not the predator in this game, you’re the prey. A fact that the E-Trades and Smith Barneys of the world will never tell you. Actively managing a stock portfolio is like
jumping into a school of hungry sharks with nothing but a mask and a pair of flippers — a reckless thing to
do.
Your benchmark is not zero
In my experience, too many investors benchmark their investment performance against nothing, zero.
They’ll say things like, “I’d like to hold onto that expensive, actively managed mutual fund because it’s
done so well over the past few years.” Then I show them charts of the fund’s performance on top of a
comparable unmanaged index fund they could have owned.
Most of the time, it proves that they could have done as well or better, with much less risk, by simply
buying and holding the index fund.
The same is true for timing TSP investments, but the comparison is often much more difficult to make.
Calculating performance when money is contributed to or withdrawn from an account requires the use of
time-weighted return calculations — something that few participants (and not very many professionals) are
prepared to make. You may remember the famous Beardstown Ladies Investment Club from the 1990s.
They made a name, and lots of money from book sales, for themselves by consistently beating the S&P
500 with their homegrown investment picks. That is, until an auditing firm came in and discovered that
they were incorrectly calculating their investment returns, and had actually lost money against the index
from the beginning.
Luck is not the same as skill
All of this adds up to one important conclusion: Beating the market is a matter of luck, not skill. Active
investment management, particularly when it comes to stocks, is like playing poker.
It’s fun if you only stand to lose a little. But is it a good choice to take your life’s savings to a table
surrounded by the best players in the world? It’s foolish. Intelligent gamblers understand the odds in the
game they’re playing and do what they can to maximize their chances of winning. In the case of the TSP,
taking what the markets deliver — the average result — while giving back as little as possible to expenses,
time and effort, is the smart play.
Written by Mike Miles
For the Federal Times
Publication May 14, 2007