Q. Is it possible to look at the historical rates of return of the various Thrift Savings Plan funds and predict an allocation for a nominal return of 6 percent, or am I better off looking into the Life Cycle funds and trying to predict the return from there? (Past performance of the L Fund income just falls short of 6 percent). My goal is to make an average of 6 percent per year on my current TSP balance to reach my retirement goal.
A. Yes, it’s possible. But you shouldn’t rely on a prediction based on so little data. There’s something called the law of large numbers that says a larger sample is better than a smaller sample in predicting the true nature of a population. If you flipped a fair coin once and it came up heads, you could expect that all future flips would come up heads based on that sample of one flip, but you’d be foolish to have much confidence in your prediction. Flip that same coin 1,000 times and you’ll have a better basis for predicting the future behavior of that coin. This is also true for investment assets. The TSP funds are based on underlying assets with much longer historical records than the funds themselves. You’ll need to use the largest set of relevant data available, including mean return, standard deviation and correlation coefficients, together with a process called mean-variance optimization, to develop the most reliable expectations for each of the funds and configure them in an efficient portfolio.