Manage risk wisely by rebalancing accounts

Now might be a good time to rebalance the distribution of funds in your Thrift Savings Plan account. This is a good idea if it has been at least six months, but particularly if it has been more than a year, since you last rebalanced your account.

If you read my column regularly, you know that I generally recommend that TSP participants find the asset allocation, or distribution of funds, that safely supports their retirement plan with a minimum of risk, and then regularly rebalance their accounts to this allocation. In most cases, this allocation will include all five TSP funds at all times.

More advanced analysts might violate this rule by integrating their TSP accounts into an overall investment portfolio that contains other investment accounts. These investors can choose to concentrate certain assets, like cash equivalents and bonds, in their TSP accounts to take advantage of the TSP’s G Fund and tax deferral.

In early June, the Standard & Poor’s 500 Index, on which the TSP’s C Fund is based and which reflects the performance of large U.S. company stocks, is as high as it’s been since the middle of 2008. What’s more, it has risen over 85 percent in the two years since it bottomed out in the spring of 2009.

Even more interesting to me is that the Barclay’s Aggregate Bond Index, which is the basis for the F Fund’s performance, is also near multiyear highs, in spite of a raft of predictions over the past couple of years that it couldn’t possibly go much higher given the inevitability that interest rates couldn’t continue any lower. Well, interest rates dropped, and anyone who bailed out of the F Fund during the past couple of years was mistaken.

Why rebalance now? Not because of anyone’s prediction about the future price of any of the TSP’s funds or the assets that underlie them. These predictions are unreliable. At any given time, you will find an equally educated, connected and otherwise qualified expert to support whatever position you like. At any time, there is someone predicting that stocks are cheap, that stocks are fairly priced and that stocks are doomed to fall.

Two of the most successful and respected bond investors have been predicting opposite fates for the U.S. Treasury bond market over the coming year based on the end of Federal Reserve’s buying program. A single event affecting a single asset class, and the two biggest names in bond fund management can’t agree on the general direction of the result. And, both of them are backing their predictions with billions of dollars of investor money.

The prudent reason to rebalance here is that the rapid pace of growth in assets has likely skewed the balance of your TSP account’s asset allocation widely off target. This alone is a good reason to rebalance the account. It will reduce exposure to the funds that have gained the most and increase exposure to the funds that have lagged the others.

This is exactly the opposite of the practice of most individual investors, whose instinct leads them to buy more of what has been doing well lately, and sell what has not.

In order to make intelligent, rather than emotional, investment decisions, keep in mind a basic truth: The higher an investment asset’s price goes, so goes the risk inherent in that asset.

The problem tends to be that humans are prone to linear predicting. They seem to expect that if something is headed up at a 45-degree angle, it will most likely continue along that trajectory. In fact, asset prices are like a kid climbing a tree. The higher he climbs, the farther he has to fall, and the more likely that fall is to be catastrophic.

As stock prices fell during 2008 and 2009, many investors ran for cover, selling more intensely as prices fell lower. Not too smart. The prudent investor was selling as prices were rising rapidly in 2003, 2004, 2005, 2006 and 2007 — before the fall. Then, a rational rebalancing regimen would have had him buying as stocks fell in 2008 and 2009.

The stock market has now done in the past two years what it took nearly five years to do after the tech market crash that ended in 2003. Rebalancing regularly to the right allocation is the best way to manage the growing risk of rising prices.