Asset Allocation is a term that should be familiar to anyone with a TSP account. It’s everywhere in the investing world, but I have found that few investors actually understand what it is and what it is supposed to do. This is a serious problem since Asset Allocation is the main driver of investment performance. In fact, study after study has shown that Asset Allocation overwhelms things like market timing and security
selection in its impact on investment results. Fortunately for you, as a participant, the TSP is recognizes this fact and makes allocating your investment assets about as easy as it could be.
The benefit of Asset Allocation was clearly demonstrated when, in 2008 and 2009, a portfolio composed of 60 percent C, S and I Funds, 37 percent F Fund and 3 percent G Fund lost only about 30 percent of its value while the C Fund, alone, lost more than 50 percent. Looking back a little further, $10,000 invested in the C Fund at the end of 2000 would be worth about $20,000 today. That same investment in the 60/37/3 allocation, rebalanced annually, would be worth about $23,000, or 15 percent more. The C Fund, alone, appreciates more rapidly in up markets, but depreciates more severely in downturns. The allocated portfolio’s advantage over the past 14+ years comes entirely from its superior performance during the bear markets of 2001, 2002, 2008 and 2009. This four years made the difference and make clear the value of Asset Allocation.
Before you can use Asset Allocation to your advantage, you’ll need to know what it is and how it works. Basically, for our purposes, Asset Allocation is the distribution of investment dollars among and between the three fundamental building blocks, or asset classes, of any retirement investment portfolio: stocks, bonds and cash. There are frequent arguments about what should qualify as an asset class, but these three get the job done nicely with the fewest number of moving parts possible. Adding additional classes,
like real estate or commodities, just complicates the matter without adding anything to the results that can’t be obtained without them. Why use more when you get do the job as well with less? As I mentioned, the TSP has removed the confusion over this issue by offering you only access to these three asset classes – stocks in the form of the C, S and I Funds, Bonds in the form of the F Fund, and cash in the form of the G Fund. I should point out, here, that the TSP would serve its purpose nearly as well – and maybe better – by consolidating the three stock funds into one total market fund and simplifying the Asset Allocation equation to its limit.
The purpose of Asset Allocation in the first place is to manage risk. Each of the three building blocks hedges, or neutralizes, some of the risk in at least one of the others. The three rarely, if ever, behave the same way, and to the same degree, at the same time. When stocks fall, bonds tend to rise as investors move from riskier investments to safer havens. When bonds fall as interest rates rise, cash holds its value. By spreading our money around, you avoid the possibility of suffering the most severe loss in any market across your entire portfolio. The goal is to reduce the severity of the dips in your portfolio’s value, admittedly at the expense of not fully participating in the biggest gains. But when it comes to producing reliable retirement income – the job the TSP is meant to do – it’s predictability that is valuable, rather than upside potential. A portfolio that produces enough return, consistently, will generally support a higher withdrawal rate than one that produces high periodic returns alternating with large losses. It takes a 100 percent gain to recover a 50 percent loss!
Here are a few general guidelines for allocating your TSP account:
- Always hold the F Fund when you are holding any of the C, S or I Funds.
- Hold the minimum amount of C, S or I Funds necessary to support your return needs.
- Never hold a portfolio composed only of the C, S and I Funds, or the F Fund. Always hold stocks and bonds together.
- Always hold at least some G Fund in your portfolio.
- Unless you can afford to hold only the G Fund, or you are holding stocks and bonds in another account, you should always be holding all five of the TSP’s basic funds.
Asset Allocation, done right, tends to smooth out the bumps, make your portfolio more predictable, and narrow down the range of possible outcomes for both your portfolio’s future value and the retirement standard of living that will safely support.
Written By Mike Miles
For the Federal Times
May 11, 2015