Many of my federal clients’ financial plans have been moving into “overfunded” territory, our periodic reviews and analyses show. This means they are planning to live beneath their means to the extent that they are taking more investment risk than necessary – or prudent – to achieve their lifetime financial goals. In most cases, this improvement in plan funding has been the result of investment performance that outpaced our expectation for the period.

A quick review of the Thrift Savings Plan’s fund performance, available at, shows that domestic stocks, as represented by the C and S funds, and bonds, as represented by the Fund, have done well since they put in their low values in 2009. The fact that they’ve both performed well at the same time is helpful. We usually expect bonds and stocks to trend in opposite directions, but the recovery from collapse in both, at the same time, during 2008 and 2009, set the stage of a simultaneous recovery.

But that isn’t the only reason my clients’ portfolios have been performing so well. I’ve used four methods to make sure their portfolios have exceeded expectations:

* First, I’ve made sure that every investment portfolio is fully diversified all the time. It’s tempting to make and act on predictions about where this or that asset type is headed during the coming days, weeks, months or years. Piling into, or out of, stocks, bonds or cash based on a speculative prediction is common. It’s certainly endorsed by many on Wall Street who are happy to help you trade into and out of securities in exchange for fees or commissions. The problem with this “strategy” is that it increases investment risk without reliably increasing the rate of return you can expect.

Bonds offer an educational example. Some of the most successful players on Wall Street began predicting large losses in bonds, particularly Treasury bonds, at least two years ago. Some of my clients were convinced and wanted to abandon the F Fund in their TSP accounts. This would have been a bad move, since bonds have been a major contributor to portfolio performance since that time. But the move was a bad one at the time, regardless of what happened afterward. It was bad because it would have left the investors exposed to the risks inherent in stocks, without a hedge.

The first question to ask in making investment decisions is: “What if I’m wrong?” This is part of the reason for full diversification – owning stocks, bonds and cash – at all times. Gambling and winning is fun, but not fun enough to make up for losing a bet that crashes your financial plan.

Second, I’ve used only two “levers” to adjust a portfolio’s investment risk and return – one that adjusts the allocation scheme and another that adjusts the size of the cash reserves. I move from one efficient asset allocation scheme to another, and/or adjust the amount of money that is exposed to that allocation scheme by increasing the amount of money set aside as cash reserves in the G Fund. In most cases, any other method of managing your portfolio will be counterproductive to safely achieving your goals.

Third, I’ve been increasing allocations to the G Fund instead of the F Fund to reduce portfolio risk, when possible. In recent times, with market interest rates near zero, I’ve been favoring increasing the cash reserves, held in the G Fund, over shifting to more bond-heavy allocation schemes. When your plan becomes overfunded, you should move to a more conservative – that is, less volatile – investment strategy to reduce unnecessary risk.

But, rather than shifting to a more bond-heavy allocation scheme to achieve this, I have been simply reducing the amount of money exposed to the allocation scheme by setting aside larger amounts of money in the G Fund before I apply the allocation scheme to the remainder. This has the effect of reducing the portfolio’s volatility without exposing it to the increased risk associated with holding bonds in a low-interest-rate environment.

Fourth, I’ve substituted G Fund for F Fund within the asset allocation scheme. After I’ve set aside the largest cash reserves possible in the G Fund while continuing to use a moderate asset allocation scheme, if possible, I’ve then gone on to substitute additional money into the G Fund at the expense of about 25 percent to 30 percent of the F Fund allocation called for in that allocation scheme.

This takes advantage of the fact that, in a zero-interest-rate environment, the G Fund guarantees a rate of return near or equal to that for medium-term Treasury securities, which make up part of the F Fund, without the corresponding risk to principal. The same return with less risk is an attractive proposition.

Written by Mike Miles
For the Federal Times

Publication September 10, 2012