Navigating bias toward TSP stocks, against bonds

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I took a look at returns for the various Thrift Savings Plan funds for the 12 months ending June 30, and here’s what I found:

* The returns on equity investments — nearly 21 percent for the C Fund, 26 percent for the S Fund and 19 percent for the I Fund — have been ahead of the long-term average.

* The negative 0.5 percent return on debt investments — the F Fund — has lagged the long-term average.

* The relationship between these two asset classes — debt and equity — is what I would expect: When equity is strong, debt is weak.

* The return on risk-free cash investments — the G Fund — is outstanding. In an environment where cash has been returning close to zero, the G Fund has returned nearly 1.5 percent.

* Overall, the performance of the various asset types, and combinations of types as represented by the L Funds, fall well within the limits of expectation set by their histories over the past 100 years.

Equity values today are near their all-time highs and debt interest rates near their all-time lows. You should know that equity values have reached their all-time highs twice before this since 2000 and, both times, this was promptly followed by market crashes that cut their value in half.

While the values of the bonds held by the F Fund are near their all-time highs, the interest being paid into the fund by those bonds is nearly the lowest it’s ever been.

Cash, as represented by the G Fund, is a special case for TSP investors. Because of its design, the G Fund offers a risk-free investment that pays a rate of return comparable to much riskier investments. It offers a risk-adjusted rate of return that exceeds anything else you’ll find, anywhere.

So, now that we know where we’ve been and where we are, it would be nice to know where we’re going. The best we can do is to try to estimate the probabilities or, at least, to identify some probable bias going forward.

The future rates of return on equities are anyone’s guess. The market for equities could crash at any time or continue to climb to another long-term bubble. I think the safest bet is that the long-term historical averages for risk and return will apply.

The future for debt is different. With interest rates near zero and values so high, it’s virtually impossible to argue that rates of return going forward won’t be below their historical averages. How much below and for how long is impossible to say.

The outlook for the G Fund is always rosy. Expect uniquely high risk-adjusted rates of return and a bias toward increasing nominal returns in the future, as interest rates eventually rise.

With this perspective, what should you, as a TSP investor, do?

Identify the correct investment allocation using expectations for risk and return based on the long-term history for each asset type. That is the investment strategy that supports your financial goals — both short- and long-term — with a minimum of risk.

Then, to accommodate the bias against bonds and in favor of cash, going forward, substitute G Fund for between 30 percent and 70 percent of the target allocation for F Fund. So, if you have selected an allocation that calls for 40 percent in F Fund and 5 percent in G Fund, reduce the F Fund allocation to something between 28 percent and 12 percent and fill the difference with G Fund, while holding the allocations to the C, S and I funds constant.

This has the effect of maintaining a neutral bias toward stocks while using the positive bias toward the G Fund to help insulate your portfolio from the negative bias toward bonds.

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Mike Miles is a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Vienna, Virginia. Email your financial questions to fedexperts@federaltimes.com and view his blog at money.federaltimes.com.

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