The Business Cycle Theory of Thrift Savings Plan Investing

In its very simplest form, the business cycle (which is also often referred to as the economic cycle or stock market cycle) simply refers to alternating periods of simultaneous expansion in economic activities, followed by a similar contraction in the same activities. This sequence is repetitive, but is not periodic, meaning that a business cycle can last from a year to more than a decade.GDP growth chart - TSP Allocation Guide

Certain types of investments do better in different phases of the business cycle. If you can determine roughly where in the business cycle you are, it becomes a relatively simple matter to put your money into the investment type which performs best during that phase.

For my purposes, I divide the business cycle into four phases: Early (recovery/expansion), Mid (prosperity/growth), Late (slow down), and Recession. Many models use different names and attempt to divide the cycle into additional phases, or to subdivide the phases into different stages. But the Thrift Savings Plan is simple – you only really have three choice: the broad stock market (the TSP S Fund), large capitalization stocks (the TSP C Fund), and bonds (the TSP G or F Funds) – and so the simple model is all that we need for determining how to determine our Thrift Savings Plan allocation.

I will explain in more detail below, but in a nutshell I allocate my Thrift Savings Plan funds as follows during the different phases of the business cycle:


Early:           TSP S Fund

Mid:             TSP S Fund transitioning to TSP C Fund

Late:            TSP C Fund transitioning to TSP F Fund

Recession:   TSP F Fund transitioning to TSP G Fund

The Phases of the Economic Cycle:

The Early (Recovery/Expansion) Phase

Thrift Savings Plan Allocation: 100% TSP S Fund

This is the phase of the business cycle with the best performance. The broader stock market, which for us means the TSP S Fund which mirrors the Wilshire 4500 Completion Index, has produced a 24% average total return per year during this phase, and its average length has been a little more than a year (15 months). Some people will refer to the TSP S Fund as representing small capitalization stocks which is true only in a relative way because of the 4500 largest publicly traded US stocks, it represents those between places 1000 and 4500, with average value of around $1.25 billion.

This phase is characterized by rapidly improving growth, declining unemployment, low interest rates, low inflation, and improving public sentiment.

The Mid (Prosperity/Growth) Phase

Thrift Savings Plan Allocation: 100% TSP S Fund transitioning to 100% TSP C Fund. As the TSP C Fund’s monthly returns catch up to and overtake the returns of the S Fund, I will transition from 100% TSP S Fund, to 50% each TSP S Fund and TSP C Fund, and finally to 100% TSP C Fund.

This phase is typically by far the longest, averaging four years, and is characterized by strong growth, low unemployment, rising interest rates, increasing inflation, and strong public sentiment.

During this phase, economic activity is strong. Economic performance by all measurements is near its peak. Inflation starts to increase, so the Federal Reserve starts increasing interest rates in an effort to “cool down” the economy as it approaches full employment.

The Late (Slowdown) Phase

Thrift Savings Plan Allocation: 100% TSP C Fund transitioning to 50% each TSP C Fund and TSP F Fund. As leading economic indicators point towards an impending contraction I will move half of my funds to the safety of the TSP F Fund to protect them from a sudden drop, while maintaining the other half in the TSP C Fund to try to squeeze out the last of the growth in the business cycle.

If the Federal Reserve is successful in slowing the economy down, this phase is known as a “soft landing”. Ideally the economy would alternate between the growth and slowdown phases. But that usually is not what happens.

The slowdown phase has tended to last a year and a half on average, and even though things are slowing, overall stock market performance has averaged 9% on an annualized basis.

This phase is characterized by slowing growth, flat unemployment, flat interest rates, slowing inflation and increasingly negative public sentiment.

The Contraction/Recession Phase

Thrift Savings Plan Allocation: 100% TSP F Fund when interest rates are flat or falling, 100% TSP G Fund as interest rates begin to rise

If the Federal Reserve overshoots its intended soft landing, the recessionary phase or “hard landing” results. Growth is contracting, inflation tends to be lower, retail sales are weak and inventory levels are high. Corporations reduce their capacity by cutting down on workers, creating an overall higher level of unemployment. The central bank reacts by cutting interest rates.

This phase has historically been the shortest, lasting a little less than a year on average, and the broader market has performed poorly during this phase (-14% average annual return).

It is characterized by weak growth, high unemployment, falling interest rates and negative public sentiment.


In my next post (How to Determine the Current Phase of the Business Cycle) I will explain how I establish where in the business cycle the US economy is currently located through a combination of economic indicators, and what the tipping points are for changing my Thrift Savings Plan allocation.



Introduction to the Thrift Savings Plan Allocation Guide

I started this blog after having the same frustrating conversation about Thrift Savings Plan (TSP) allocation which I have had with co-workers dozens of times over the past few years. So many of my colleagues are incredibly smart, hard working people who are great at what they do, but they don’t have a basic knowledge of investing. Without a well founded Thrift Savings Plan strategy, their retirement accounts are hinging on blind luck and bad advice, and I genuinely fear for their financial security down the road. I started typing up a quick email for one of them to explain how I invest in the Thrift Savings Plan, and a few thousand words later I had written most of what is on this site today. I am sure that a great many Feds and military service members out there are in the same position, so I stuck it online to try to help some others who want to make the most of the opportunities provided by the Thrift Savings Plan, and avoid catastrophic mistakes.

I became a Fed about 20 years ago with no savings and almost $100,000 in law school debt. With no income other than my GS salary, I now have $2,000,000 invested in the stock market – about half of that because I have made good decisions with my Thrift Savings Plan allocation. As a result, I have hundreds of thousands of dollars more in my Thrift Savings Plan than most of my peers do. I’m not telling you this to brag – I just want you to think for a minute about what is at stake for you.

My Thrift Savings Plan strategy isn’t a secret, it isn’t particularly technical, and it isn’t hard to do once you develop a basic understanding of what is commonly referred to as the business cycle. This isn’t another attempt to time the stock market – we look at broad economic trends rather than easily manipulated stock market patterns. And it doesn’t require a lot of machinations and decisions – on average I change my Thrift Savings Plan allocation about once a year (and sometimes go years without touching it). You just have to be willing to devote a few minutes a month to figuring out where in the business cycle we are at any given point (and there are plenty of experts out there whose advice you can follow who do nothing but figure that out) and invest in the TSP funds which do well during that phase of the cycle.

Feds and service members allocate their Thrift Savings Plan badly for a lot of reasons. Most TSP talk revolves around simplistic, outdated and flat-out wrong axioms like: “buy and hold” is the key to successful wealth building, being diversified results in better returns, and an investor’s career stage largely determines what they should be invested in. If followed, all of those half truths and fictions will lead to huge losses when the economy contracts, and tremendous missed opportunities as it expands.

rolling dice tsp allocation strategy guideBut maybe the worst reason that I have heard over and over again when we have the TSP talk is they don’t want to be bothered with it – they want to set it and forget it. The problem with doing that is that none of the options offered in the Thrift Savings Plan is the right choice 75% of time. My colleagues work hard for 50 to 60 hours a week, but they don’t want to spend twenty minutes a month to make investment decisions which can often make the difference of thousands of dollars in a single day. I don’t want to spend my days worrying about it or doing research either, but I am willing to do a little bit of reading occasionally and to adjust my Thrift Savings Plan allocation on rare occasion. The difference between “set it and forget it” and “set it and adjust it once every year or two” could be hundreds of thousands of dollars as they approach retirement.

Here is the nutshell of my TSP strategy in its very simplest form: the business cycle is a long-term pattern of changes in the economy which follows four stages: expansion, prosperity, contraction, and recession. Each of the basic Thrift Savings Plan funds (the S, C, G and F funds) do very well in one of those phases, but are either flat or do terribly in others. The cycle is not exact and the phases last different amounts of time and result in different fluctuations each time, but it provides the basic framework for selecting the best TSP allocation.

A host of other factors impact the stock market and your Thrift Savings Plan balance on a daily and weekly basis. But external events, no matter how much importance they are given in the 24-hour news cycle, have very little impact on the business cycle. Certainly a poor jobs report, a sovereign debt default by a European country, or prospects for armed conflicts overseas may cause the markets to fluctuate, but they do not effect the long term trends which this strategy aims to capitalize on. As a result, we do not worry about weekly, or even monthly declines in the stock market and focus on the big picture.

Nobody can predict exactly when the phases of the business cycle will change. And that isn’t my goal. When you look a chart of GDP growth rates (the standard by which the economy is generally measured) and you see the broad trends of the economy going up and down, my goal is to miss most of the losses which that downward sloping line represents in my Thrift Savings Plan, and to be on board for most of the gains which the upward sloping line represents. Note that I’m not trying to do that for the minor fluctuations, I don’t believe that anyone can accurately predict those, but rather for the major cycles in the economy. In my next post I will write in much greater detail about the characteristics of the different phases and the indicators which predict roughly when one phase is going to end and the next begin.

US GDP Historical Growth Chart TSP AllocationAt any given point in the cycle, one TSP fund is typically doing very well and the others are doing poorly relative to that fund. As a result, trying to create a balanced mix of TSP funds (or investing in the LifeCycle funds) results in the gains which are made by the strongly performing funds being canceled out in at least some measure by the funds which are weak during that part of the cycle.

The TSP I Fund (International) does very well during certain phases of a business cycle too, but it is participating in a completely different cycle than the US business cycle which governs my selection of the S, C, G and F funds. To invest in the TSP I Fund, you have to understand where the economies of the countries which dominate that fund are in their business cycles. That’s a subject I cover in great detail in this post.

The TSP G and F funds are typically lumped together as “fixed income” or bond funds, but they have very different characteristics which I explain in F Fund vs. G Fund in TSP Allocation. The cliff notes version is the G Fund provides guaranteed, but very low interest, while the F Fund will do very well when interest rates are falling, but can have negative returns when rates rise.

I do not have any financial motive in starting this blog, I am just trying to help a few of my colleagues with the benefit of the experience and time that I have put into this subject. Since I’m going to the trouble of writing it all down, I feel like the larger the audience I can reach, the better, so I have created this page instead of just emailing it to a few friends. I have been inspired by the example of Dan Jamison and all of the time and effort that he has put into his FERS GUIDE (which every Federal employee should read from start to finish on their first day of work and once a year after that). If I have a long-term goal with this blog, it is to eventually create something which approximates for the Thrift Savings Plan what he has created for the Federal Employee Retirement System.

Please note that I’m not telling what you should do with your Thrift Savings Plan or suggesting that you follow what I do. My goal is for this to be a transparent, straightforward, free resource for Feds and service members, and for it to be one of many viewpoints they consider when making important decisions about their financial future.

So what should you do now?

  1. Subscribe to receive email updates so that you will know when I change my allocation or post about another topic of interest (I only send one email per month with an update on where we stand in the business cycle, and promise I won’t share your email address);
  2. If you find value in what I am doing here, please share it with your friends and colleagues by clicking on the email or social media buttons below;
  3. Keep reading. In The Business Cycle Theory of Investing I will go into much greater detail on the Business Cycle and which Thrift Savings Plan fund I invest in during each phase.

Continue to The Business Cycle Theory of Investing