The Federal Thrift Saving Plan has many good features. But being limited to only five Vanguard mutual funds reduces participants’ gains and worsens their losses — unless those account holders know how to add an easy momentum factor to their choices.
Parts 1 and 2 of this column appeared on Nov. 20 and 22, 2018.
As we’ve seen, the Federal Thrift Savings Plan (TSP) can be greatly improved by a simple asset-allocation strategy, even though the program has severe restrictions. TSP prohibits account holders — more than 5 million government employees — from investing in individual stocks. It offers only five mutual funds, which hold just US stocks and bonds plus non-US stocks. There are no funds that provide diversifying exposure to real estate, commodities, non-US bonds, or other asset classes. In addition, TSP has a handful of target-date funds that merely combine the other funds. And participants cannot make changes in their account positions more than twice a month.
Despite those limitations, Part 2 of this column showed that TSP account owners could increase their annual returns almost half a percentage point while reducing their losses. Instead of TSP’s bear-market drawdowns of 22% and 29% — losses that would compel many people to liquidate — a simple method of selecting the strongest funds once a month kept those losses to no more than 11%. Most people can tolerate small fluctuations like that, especially when the S&P 500 (including dividends) was down more than 50% in the global financial crisis.
In this part of my column, we’ll see the easy-to-follow rules that TSP account holders (or the owners of almost any 401[k]-type plan) can adopt to increase their gains and reduce their losses — the twin goals of every serious investor.
Understanding the asset classes in your savings plan
The first step in upgrading any 401(k) or other savings plan is knowing what choices you can select.
One reason I’m analyzing here the government’s TSP scheme is the millions of people it governs — twice as many as the 2 million people in all Vanguard-managed 401(k) plans for corporations.
TSP is not available to the general public or anyone who does not qualify as a federal government worker or a member of the military. However, a website that tracks the performance of thousands of 401(k) plans including TSP — My Plan IQ — shows us the five primary mutual funds that the plan offers.
My Plan IQ names five Vanguard Investor-class mutual funds. However, just last week Vanguard announced that 38 of its high-minimum Admiral-class funds would lower their buy-in to $3,000 from $10,000. These 38 newly accessible Admiral funds are replacing Vanguard’s corresponding Investor funds. The Investor funds could always be purchased with a lower $3,000 buy-in. Vanguard has now closed to new investments the related Investor-class funds, since they no longer have any advantage over the Admiral funds.
Anyone who doesn’t work for the federal government could, in theory, purchase the following mutual funds — or the Vanguard ETFs that have identical performance — to duplicate the return of TSP (without the tax-deferred benefits, of course):
Investor-class / Admiral-class / ETF
- VFINX (closed) / VFIAX / VOO: the S&P 500 index
- NAESX (closed) / VSMAX / VB: every US stock that isn’t in the S&P 500
- VGTSX (closed) / VTIAX / VXUS: mostly large-cap stocks outside the US
- VBMFX (closed) / VBTLX / BND: US federal and corporate bonds
- VBISX (closed) / VBIRX / BSV: US short-term Treasury notes (1 to 5 years)
That fifth fund — the VBIRX Admiral-class fund and its ETF twin, BSV — would benefit from a bit of explanation. TSP’s short-term government bond fund (known as the G Fund) is a special animal. It has a guaranteed return with immediate access to your cash, like an interest-bearing checking account. But it yields the higher interest rate of Treasury debt obligations with maturities of 4 years or longer.
Few interest-bearing checking accounts or money-market funds can come close to the yield of the G Fund. My Plan IQ reports that the fund returned 1.7% annualized in the 10 years ending Nov. 19, 2018. By contrast, the website says “cash,” such as the average money-market fund, returned only 0.2% annualized in the same 10-year period.
Members of the public can’t buy TSP’s G Fund, of course. So I've selected VBIRX and BSV as Vanguard’s closest matches. Both VBIRX and BSV returned 2.2% annualized in the past 10 years, according to Vanguard. That’s close enough to the G Fund’s 1.7% annualized for our purposes.
Adding a momentum rule to supercharge TSP
Since Jan. 2, 2001, My Plan IQ has tracked daily — in real time — two versions of TSP. They are a buy-and-hold version, called “strategic asset allocation,” and an asset-rotation version called “tactical asset allocation moderate.” To its credit, My Plan IQ publicly discloses the rules for both portfolios and shows the performance results that it’s tracked by now for almost 18 years.
The strategic version uses the following strategy:
- My Plan IQ adopts the common wealth-management policy of holding 60% equities and 40% bonds.
- The 40% bond portion of the portfolio is held in government fixed-income securities.
- The 60% equity portion is split evenly between US and non-US equities.
The tactical version uses the following strategy:
- My Plan IQ requires that the portfolio hold at least 40% in fixed-income at all times.
- The website each month selects up to two other TSP funds: the ones that have the strongest momentum.
- The momentum ranking is determined by averaging five numbers: each fund’s return over the past 1, 3, 6, and 12 months and the past 1 week.
As we saw in Part 2 of this column, the tactical portfolio returned 6.0% annualized in the years 2001 through 2017 with no more than an 11.1% drawdown. The strategic portfolio returned only 5.6%. Worse, the buy-and-hold portfolios subjected TSP account holders to nerve-wracking losses of 21.6% in the dot-com crash and 29.0% in the global financial crisis.
These figures are not backtests, but real-time tracking that has been openly published for almost two decades. And My Plan IQ doesn’t curve-fit a different formula onto each tactical portfolio. Instead, the website admirably uses the same averaging calculation for all of the thousands of asset-rotation alternatives that it monitors. This formula is based on research that has won the Nobel Prize in Economics, showing that returns over the past 12 months have a tendency to predict returns in the next one month. (See my Muscular Portfolios summary for details.)
In the final part of this column, we’ll see exactly how to implement this for employees who are stuck in TSP’s limited set of asset classes — and for anyone else in any other institution’s similar plan.
Part 4 of this column appears on Nov. 29, 2018.
With great knowledge comes great responsibility.
—Brian Livingston
CEO, Muscular Portfolios
Send story ideas to MaxGaines “at” BrianLivingston.com
