Ask The Experts: Money Matters

By Mike Miles

Risk efficiency

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Q. I saw you use the term risk efficiency in a recent response, and it made me curious. I have a nice little amount in the Thrift Savings Plan now. I don’t think I will be needing it in the future, except to hand down to future heirs, and so have tried to maintain a 70 percent stocks (35 percent C, 15 percent S and 20 percent I), 15 percent F, 15 percent G ratio. I read in a financial magazine (sometime around 2009) that a 70/30 ratio of stocks to bonds and/or cash reduced the risk considerably over a 100 percent stock portfolio, and didn’t reduce returns significantly. Do you agree, or do you have some other thoughts on what is risk-efficient for long-term growth?

A. Risk efficiency is a measure of how close an investment portfolio lies to the “Efficient Frontier” — the set of portfolios that mix assets together in ways that produce the maximum expected rate of return for the level of risk they produce. I can’t tell you how risk-efficient your asset allocation model is, but I’d guess it’s pretty risk efficient. Note that this doesn’t mean that it’s risk-appropriate. The correct asset allocation will be both.

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TSP allocation

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Q. I have 14 years of federal service and have always been in the C Fund 100 percent, currently with $230,000. For the past few years, I’ve contributed at 15 percent. I was not very attentive to my Thrift Savings Plan and, after 2008, was leery of moving after the big losses and getting into L2030. In 2013, the C Fund was amazing, but 2014 has been way down so far. How do I know the right time to transfer the whole thing to an L Fund, and is that the right thing? I will probably retire by 2035.

A. Your current asset allocation scheme is risk-inefficient. You should move to the appropriate risk-efficient asset allocation scheme, using all five of the TSP’s basic funds, as soon as possible.

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Mortgage and C Fund

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Q. I retired Jan. 31, 2013. I have more than four years left on my mortgage. I owe about $25,000 on my loan. I was thinking of taking a lump sum from my Thrift Savings Plan for about $20,000 and use my tax refund to make up the difference I would owe. I have about $120,000 in my TSP. I’ve had it in the C Fund, which is doing very well. Do you think it’s a good idea to take a lump-sum withdrawal to pay off my mortgage? It would save me $900 per month, which is what I’m paying for my mortgage.

A. If you plan to leave all of your money in the C Fund going forward, it might be smart to use some of it now to pay off your mortgage before you lose it. You should note that the C Fund isn’t “doing very well,” it has done very well. Those are two different things. The question you should asking is: “What could it do in the future?” Since 2000, it has lost half of its value – twice.

The best decision about your mortgage will depend upon a number of factors, including your tax returns, how you will manage the money going forward if it’s not used to pay off your mortgage, the terms of your current mortgage and the demands you will place on your TSP account in the future.

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G Fund

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Q. In your recent column “4 keys to TSP success,” you mentioned, regarding asset allocation, to “diversify your holdings among cash, stocks and bonds to hedge the risk lower.” I agree with this approach wholeheartedly, but ask where in the TSP to keep “cash”? There is no money market option, just the L funds (which I don’t use, preferring to personally allocate my investments), and the G, F, C, S and I funds.

By the way, I took everything out of the G Fund and ceased all future allocations to it when there was a proposal by our leaders last year for the federal government to be able to borrow against it. Do you have any update or comment on this proposal?

A. The G Fund is a cash equivalent with an above-market rate of return. It’s as safe as anything you’ll find.

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Moving balances between TSP funds to avoid market downturns

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Q. Does the Thrift Savings Plan allow one to shift all of his C Fund balance to the F Fund to wait out an expected downturn in the S&P 500? I know one generally should not try to guess the market, but if one could stay ahead of downturns and upturns (in theory), would it be more profitable over the long term (10 to 20 years) to shift out of C to F temporarily rather than suffering through market downturns (as in 2001-02 and 2008)? I guess it’s like selling high and buying back in low, assuming one’s timing was spot-on.

A. This is allowed, but as you point out, not a reliable investment strategy. You could do better.

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TSP withdrawals and investments

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Q. I am a civilian FERS employee who will retire this summer at age 59 with 35 years of civil service.  After retiring, I intend to start monthly withdrawals from my Thrift Savings Plan account ($2,000 per month). Even though I will have begun making monthly withdrawals from my TSP account, can the remainder of my money in the TSP continue to be invested in the various funds (G, C, F, S, I) and continue to grow via earnings within these funds?

A. Yes.

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Diversifying from G Fund

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Q. A sad tale: I am 64 and still working for the Defense Department. For most of my career, I have left my money in the G Fund except for some short periods where some of it was in the C Fund. I now have $430,000 in the G Fund but just can’t find it in myself to diversify although I see that I have lost a lot of money over the years this way. Can you recommend a relatively safe future strategy that won’t keep me awake at night?

A. Find a trustworthy and affordable adviser to help you.

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TSP allocation

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Q. I have reverted back to a more conservative Thrift Savings Plan allocation: 67 percent G Fund/33 percent C Fund. I put in the maximum, including the maximum catch-up and, with match, it’s nearly $30,000 per year. My balance at 60 when I retire in five years should be between $500,000 and $600,000 depending on the return.  I am estimating a 4 percent return.

I am wondering about keeping this asset allocation and taking monthly payments starting near 4 percent or slightly higher at age 60. Is a distribution with 70/30 as indicated above a bad idea? I like the conservative allocation and feel fairly comfortable with it. But some people say taking monthly payments out of TSP is a bad idea. Any suggestions?

A. It’s impossible to judge what’s best for you from the information you’ve provided. I can tell you that your asset allocation model is risk-inefficient. That is, you could achieve a higher rate of return for the risk you’re taking.

Adjusting your allocation to 20 percent C Fund, 8 percent S Fund, 2 percent I Fund, 30 percent F Fund and 40 percent G Fund will stay within your preferred 70 percent debt/30 percent equity constraint while increasing sustainable TSP lifetime withdrawal rate by about 20 percent.

Greater increases could be achieved by shifting toward more equity-heavy allocation models.

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TSP allocation

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Q. I’m 32 years old, have been contributing to the Thrift Savings Plan since 2005. I have 40 percent in my C Fund, 30 percent in S and 30 percent in I. Is this a good contribution allocation? I want to be as aggressive as possible, but I am also looking at moving most of my gains to the G Fund due to the fact the market may be headed in the same direction as 2009. If I want to protect my gains with the means of buying back at a lower price, what would be your recommendation be on rebalancing the money in my account and adjusting percentages on new money coming in?

A. You’re asking me how to implement your investment strategy. If you don’t know how to manage it, why are you using it in the first place? What do you know about that asset allocation you’re using? How is it likely to behave? What is its expected return? What is the standard deviation of those returns? How do these characteristics support or threaten your lifetime financial plan?

As I’ve pointed out many times, your question is like asking me how work the controls on your care without telling me where you are, where you want to go, what stops you want to make along the way, when you’d like to get there, what kind of car you’re driving or how much fuel you have in the tank. Your investment tactics should be based on an investment strategy which includes cash reserve and asset allocation targets, securities selection and transaction timing algorithms.

I don’t manage portfolios the way you are managing yours because there is too much uncertainty that could be avoided. The best advice I can give you is to recommend that you identify the investment allocation that will support your lifetime financial goals with a minimum of risk and then rebalance to that allocation on a regular fixed schedule — at least once per year and not more than four times per year.

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Focus on the future, not the past

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Here are the five basic Thrift Savings Plan funds in order from the highest to the lowest rate of return for the month of October: C Fund (4.60%), I Fund (3.38%), S Fund (2.94%), F Fund (0.89%), G Fund (0.19%). And here are the year-to-date results: S Fund (31.13%), C Fund (25.34%), I Fund (19.43%), G Fund (1.52%), F Fund (-0.78%).

Interesting? Maybe to some. Useful? I don’t know how.

As an investment manager — or TSP participant, as you are more commonly known — you are responsible for making, or delegating the making of, a massive series of decisions. Some of these decisions, like whether you contribute to the Roth or the Traditional TSP accounts, will most likely wind up being relatively insignificant. Others, like the distribution of your money among the available funds, will be instrumental to determining your financial future. As I’ve written before, making sure that the important decisions are the best they can possibly be is your primary objective as an investor. If you’re not sure which are the critical decisions, you’d be safe to make sure that every decision you make is the best it can be.

This brings me back to the question about the usefulness of historical performance data for the TSP, or any other, investment securities. Is it of any real value? I don’t believe it is. There is no strong evidence that this information, at least in the short run, is useful for predicting future results. You can’t go back and make decisions based on it. So, what good is it? Really, it’s no good at all. In my experience, it causes problems and leads to bad decision-making.

Two wrong-headed mistakes are often made. The first is the incorrect belief in the “due theory.” This is the fallacy that the probability of an independent event occurring goes up as the event does not occur: “I’ve just flipped 10 heads in a row, so the odds of flipping a tail on the next try are greater than 50 percent.” Not true!

The second, and I think more common, mistaken belief for investors is the momentum of inertia theory. This is belief that an independent series of events is likely to continue on its current path: “I just flipped 10 heads in a row, so the odds of flipping a head on the next try is greater than 50 percent.” Wrong again.

Sure, you can find historical records that support either of these theories, but that doesn’t mean they make any sense. You can find support for just about anything through back-testing large, randomly generated data sets, and a series of unpredictable events often shows surprising runs of luck, good or bad. Patterns appear to show up just about anywhere you look for them, even in random data.

Finding a pattern in history and predicting one in the future are two very different things.

As an investment manager, your job is to be concerned with two things: Where you are today and how best to get where you want to be in the future. While the past has put you where you are today, you don’t need to know anything about the past to assess your current position. And the kind of historical data published for specific investment securities, like funds, is not needed for use in making decisions about how to proceed in the future. In short, this information is useless to you in managing your TSP account or any other investment account.

Even the effect historical data tends to have on investors is unreliable, if not outright dangerous. Many of the investors I’ve talked with over the years tell me they feel great when their account values have risen quickly or steadily to a new high. Likewise, they feel bad when their account values have fallen. These effects tend to make them want to invest more, or more aggressively, on the heels of good market results and withdraw their money from risky assets after bad results. Data on investor behavior confirms this behavior. Unfortunately, it is irrational and harmful. It is rational to become more cautious as prices and values rise, and more confident in your investing as they fall. The key to successful investing lies not in tracking the price history of investment securities, but in understanding and accommodating the probabilities of their future prices. Done right, it is a prospective, rather than a retrospective, exercise. So, it’s OK to be entertained by what happened yesterday. Just don’t make the mistake of confusing this with what will most likely happen tomorrow.

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