As a TSP participant, your investment strategy is the way that your account balance is distributed, or allocated, among the TSP’s five investment funds, over time. Your strategy includes how your balance is allocated now, and how it will be allocated in the future. So, an investment strategy is a sequence of asset allocation decisions and schemes over time. The quality of your investment strategy will be determined by how well your account supports your goals. Goals for a TSP account are typically expressed as some combination of periodic distributions and an ending value. But, how do you know which strategy is best for you?
The best investment strategy, for you, is the one than minimizes the risk, or probability, that your account assets will under-perform your expectation or need. In practice this means that your portfolio must produce the returns you’ll need to support your goals with the least possible risk. If you need 8 percent return each year to make your retirement plan work, then you should focus your account management efforts on producing 8 percent per year as consistently as possible. In this case, using an investment strategy that is intended to produce 10 percent per year may be so risky that it actually impairs your ability to earn 8 percent, compared to a less aggressive strategy. Chasing too much return can actually hurt your ability to earn enough return – a trap that far too many investors fall into.
There are two characteristics that describe the behavior of any investment strategy or portfolio. They are the Expected Return, or ER, and the Standard Deviation of Returns, or SDR. The ER describes the most likely return over a particular period of time, and the SDR describes the likelihood that the actual return for a period will be different than the ER. Calculating these statistics can be difficult and mistakes are common, but without them, it’s impossible to make informed investment decisions.
In finding the best strategy, you should first make sure that you only consider alternatives that are expected to produce their ER with the lowest possible SDR. If two strategies each produce an ER of 8 percent, the one with the smallest SDR is better. To find the best investment strategy, find the ER you need with the smallest SDR.
Written by Mike Miles
For the Federal Times
Publication September 2017