If you are a TSP participant, do yourself a favor and ignore your Personal Rate of Return! This nearly useless piece of information is provided by the TSP in your quarterly statements. And, while you might find this number interesting – either exciting or disappointing – it tends to draw your attention away from truly important information, and focus it, instead, on something that is of little use in managing your account or planning your retirement.
Your Personal Rate of Return, or PROR, is a number that pretends to quantify the performance of your TSP account over the most recently competed twelve calendar months. Unfortunately, there a number of problems with this statistic that make it useless, at best, and dangerous to use, at worst.
The PROR using the wrong method of calculating a rate of return a TSP account. The PROR reports something called the “Time-Weighted Rate of Return’ for your account over the most recently completed twelve calendar months. This calculation method effectively “scrubs out” the effects of any deposits to, or withdrawals from, your account during the period, and pretends that your account produced a return that it did not produce if you made contributions or withdrawals. Time-weighted returns are intended to be used in evaluating the performance of an investment manager in beating a particular benchmark, like a market index or average. Since cash flows into or out of the portfolio affect its growth, time-weighting is used to remove these affects so that the manager’s performance can be highlighted for comparison to the benchmark. The TSP only allows you to invest in index funds that are based on what are commonly used as benchmarks for comparison in evaluating a manager’s ability to time the market. Since you can’t do anything in the TSP to beat the funds you are invested in, time-weighted return calculations are inappropriate for measuring performance in the TSP.
The data sample used to compute the PROR is too small to be meaningful. The PROR is based on only one of a massive number of possible year-long periods that make up the TSP’s history. Consider that in every ten-year period, there are about 3,285 different year-long periods if we consider every pair of beginning and ending dates that are 365 days apart. In the nearly thirty-year history of the TSP, there are more than 10,500 year-long periods, based on days. If you project the historical performance of the various funds backward to the early twentieth century, which is possible using proxies for the funds, the number of historical years grows to more than 30,000. Assigning any significance to a single one of these data points is not unlike treating the one of many thousands of flips of a coin uniquely important. The Law of Large Numbers in statistics tell us that a larger sample of something is always a better predictor of the true nature of that something, than a small sample. If you’re trying to judge the behavior or performance of your TSP account, or any of the funds, on a single data point, you’re making a mistake.
The PROR comes too late. It should be obvious that the PROR is nothing more than a look in the rearview mirror. And like a look in the rearview mirror, the PROR tells you absolutely nothing about what lies ahead. Pretending that it does is also a mistake in that by doing this, you are placing your trust in something that is unlikely to guide you to your destination. As your TSP account’s manager, your primary concern should be with what could happen in the future, and the probabilities associated with the various possibilities. Once it has passed, your PROR is of little or no use to you.
On its own, the PROR is meaningless. The utility of the PROR is clearly evident when you consider what you’ll do with it when you have it. Say, for example that the your most recent PROR is 5.2 percent. What can you do with this information? You owned the account during the period measured by the PRORO and, even if you don’t like the result, it’s now too late to re-write history. When it comes to investment management, the decisions you face are entirely prospective. Except in FERRCA cases, you’re not offered the opportunity to go back and do it over again. And the PROR definitely will not tell you anything about the future performance of a fund, or combination of funds. So, do yourself a favor and ignore the PROR. Focus your attention, instead, on predicting the future.
Written by Mike Miles
For the Federal Times
Publication February 13, 2017