Should I be timing the market in my TSP account?” I hear this question regularly, in one form or another, from Thrift Savings Plan participants. More recently, the question has been asked in reference to services that propose to provide market-timing guidance to TSP participants for a fee. The answer is a resounding “no.”
Ever since the introduction of the Thrift Savings Plan, there have been discussions among participants about the best way to manage their accounts. Participants’ ability to switch into and out of the TSP’s five funds without noticeable transaction costs spurs interest in active trading strategies, specifically market timing, that might not be practical otherwise. The allure of active investment management — trying to improve on the market’s performance — is encouraged through advertising and other biased messages in the popular media.
The problem is that active management, including market timing, does not stand up to rigorous and informed scrutiny when compared with the more passive alternative — strategic asset allocation. This is true when the timing decisions are made by the participant, and even more pronounced when the decisions are purchased for a fee.
The TSP is designed to support passive investment management. The funds themselves are passively managed index portfolios. The advantages of this type of investment strategy include low administrative costs and relatively high reliability of future results.
The reliability of future investment results is pertinent to the consideration of all timing strategies, whether provided for fee or without cost. Market timing introduces human decision making into the investment management process. Without market timing, the only decisions required involve the selection of the asset allocation model and the frequency of rebalancing the account to the model’s allocation. Market timing implicitly involves both of these decisions, plus another: deciding which funds will be hot and which will be cold during some future period. This additional decision carries with it additional risk — the risk of being wrong. Increased risk means decreased reliability in predicting future returns.
Investing is a prospective game. It is gambling. And gambling is a game of probabilities. An opportunity where the risks outweigh the rewards is a “sucker’s bet.” Yet investors too often seem willing to pursue potential returns without regard to their odds of success or failure. Compared with a properly executed passive asset allocation strategy, like that available in the TSP, market timing offers increased risk without correspondingly increased expected returns — an offer that a prudent investor should decline.
Adding the cost of using third-party guidance to the market timing strategy only makes things worse. The expected return for any investment strategy is the expected return for the market or markets to which it is applied, less any costs that it generates. When the market-timing strategy is assumed to be cost free, the costs for both strategies were equal to the TSP’s fund operating expenses and could be ignored. Paying for advice will lower the market timing strategy’s expected returns by the amount of the fees to be paid. In this scenario, the market-timing strategy will actually produce increased risk and lower expected returns than the asset allocation alternative — not what I would call a wise investment.
The tactics used to sell market timing services should also dispel interest in them. Any time someone or some entity asks to be paid for a service while simultaneously disclaiming all responsibility for the results you achieve by using the service should be highly suspect. I and other professional advisers willingly accept responsibility for the advice we provide our clients. We’re subject to regulation as investment advisers and accountable, not only to clients, but also to the regulators. Any timing service that exempts itself from regulation by claiming to be in the business of providing information rather than advice should be suspect. And most important, any service that claims to be able to beat markets or produce superior investment results in the future should be suspect, particularly if it uses past results — or worse, hypothetical past results — as evidence. Hypothetical past results — that is, results that could have been achieved, but weren’t — are often used to compensate for weak credentials and experience of the source of investment advice.
Written by Mike Miles
For the Federal Times
Publication June 13, 2005