THIS IS AN ARCHIVE POST. CLICK HERE FOR THE CURRENT TSP ALLOCATION GUIDE UPDATE.
As promised, I did a little pondering over the long Christmas weekend and have come up with a plan for how I am going to transition from the TSP S Fund to the C Fund over the next few months.
You will remember that I am doing so because I believe we have reached the transition between the Recovery Phase and the Growth/Prosperity Phase of the Business Cycle. The Growth/Prosperity Phase is characterized by strong growth, low unemployment, rising interest rates, increasing inflation, and strong public sentiment. (There is a great deal of detail about the different phases of the Business Cycle in my post: The Business Cycle Theory of Thrift Savings Plan Investing). At 5% unemployment, we are well within the range of full employment, the Fed has started raising interest rates, and inflation has started to increase (although that has not shown up in a lot of the standard measures due to the effects of very low fuel prices over the past year). I would not characterize the growth we are seeing in the economy nor public sentiment as particularly strong, but when viewed in totality I think the present state of the economy and the indicators puts us into the Growth/Prosperity phase over any other.
As I have said many times before, I tend to believe that at any given point in the business cycle there is really only one domestic TSP fund (C, S, F and G) which is likely to outperform all of the others. I think we have reached the point where we are far enough into the transition between phases that the vast bulk of my investments should be in the C Fund or its equivalents. And I still believe that the I Fund is positioned to perform well on the International front, so I plan to maintain my 15% allocation in that vehicle for the time being.
I don’t feel the need to do this precipitously, and I do believe the S Fund may be due for a bit of a run, so I will average-in this change by spreading it across the next few months. I will make one allocation and contribution change today (12/28), and then anticipate making another on the day following my monthly update for the next four months. (There is nothing magic about the percentages I am moving each month or the dates on which I am making the moves – in this case I am moving it the day after whatever day I happen to publish my update just to save both of us the effort of writing and reading two updates each month). So my allocation will likely look something like this:
- 12/28: 55% S Fund, 30% C Fund, 15% I Fund
- January: 40% S Fund, 45% C Fund, 15% I Fund
- February: 25% S Fund, 60% C Fund, 15% I Fund
- March: 10% S Fund, 75% C Fund, 15% I Fund
- April: 85% C Fund, 15% I Fund
And as always, I will adjust my contribution allocation and conduct an interfund transfer to match those percentages each time I make a change.
As I said above, there is nothing magic about this plan – I could move the money between funds in 10% chunks or 30% chunks and I doubt it would make a difference. My strategy is very much based on the big economic picture, which is measured in quarters, not days. That means there is lots of room for variation, and my returns aren’t driven by guessing at trading points but rather by buying and holding the right fund over a period of years.
I always try to remind readers that this is just what I am doing based on my circumstances, and isn’t necessarily a recipe for what anyone else should do with their Thrift Savings Plan. Because I believed we were in that grey area between phases, I probably would have started moving money in my TSP from the S Fund to the C Fund several months ago except that I already held several hundred thousand dollars worth of C Fund equivalents (S&P 500 ETFs and mutual funds) in my non-TSP accounts. So I was already effectively straddling those two positions overall, if not in my TSP. I pointed that out each month and noted that I would have been comfortable with just about any mix of S, C and I funds during that grey area period.
I am definitely curious as to what other investors think about my plan and what they are doing themselves, so please do share in the comment section below or on the message board.
Thanks for reading, and please share the site with your friends using the sharing buttons below. You can even just print a copy and stick it in their mailbox if you want to be all sneaky about it.
The original December update is below, and is still very much worth reading if you haven’t caught up on emails from over the holidays.
12/23/2015 (the original December update)
This month’s update will be short for a few reasons: there isn’t any major news on the economic front, we both have better things to be doing this week, and I will be doing the big look back/look forward posts in the next few weeks.
Bottom line up front: my current Thrift Savings Plan allocation remains 85% in the TSP S Fund and 15% in the TSP I Fund for at least another few days (this reflects both my contribution allocation as well as where my existing balances are invested). As we will discuss below, at this point in the business cycle it is time for me to start transitioning from the TSP S Fund to the C Fund and I will be starting to do that very soon. (Skip down to the ‘TSP S Fund Conclusion’ section for that discussion if the economic indicators run down is just too boring to read.)
The Federal Reserve finally raised interest rates and it turned out to be a bit of a yawner after all that anticipation, with the market not having a particularly strong reaction either way.
What does this mean for us? For stock prices, almost nothing. After the Fed raises rates by a quarter point another six or seven times we might see some money moving from the stock market to the bond market, but at this point the change is so small as to be almost meaningless. This move will tend to strengthen the dollar slightly against other currencies (particularly the ones represented by central banks which are actively lowering their own rates), making US exports more expensive (which is not a positive for the S and C funds), and making European and Japanese exports less expensive (which is good for the I Fund). I believe the Fed will move cautiously and slowly going forward, with perhaps only two rate raises in 2016.
There was a fair bit of volatility in the market the last couple of weeks, which always causes some angst among readers. I don’t believe this was caused by the Fed’s actions, but rather by a minor panic in the junk bonds market. Here’s how it played out: new oil price forecasts came out suggesting that oil prices will not start to recover until the second half of 2016. Smaller energy companies are significant issuers of junk bonds (corporate bonds which are rated as riskier) – they use the proceeds of the bond sales to buy equipment, drill wells, etc. The fear is that some of these companies will not survive until oil prices recover and as a result will default on their bonds. Even though these energy companies only comprise a small percentage of the junk bond universe (11% or so off the top of my head), enough investors started selling their junk bond mutual fund holdings to cause a “run” on the funds. Junk bonds are fairly illiquid, so at least one mutual fund had to freeze redemptions while they worked to sell bonds. Panic in that sector bled over into the overall market and nervous traders pulled out to wait for the dust to settle (as they do).
Pretty exciting stuff, huh? This is why there are so many more sports blogs than financial blogs. But nothing to indicate long term trouble for the stock market, which is what we care about
TSP Allocation Guide’s performance year-to-date: -1.23% (updated to reflect through market close on 12/23/2015).
Ugh. Another day or two like today will get me back into the green for the year, but I hate flat years like this and depressed oil prices continue to weigh disproportionately heavily on the S Fund. The good news is that flat years tend to be followed by up years, so that bodes well for 2016.
Year to date Thrift Savings Plan fund performance:
• TSP C Fund: 2.44%
• TSP S Fund: -1.99%
• TSP I Fund: 0.59%
• TSP G Fund: 2.00%
• TSP F Fund: 0.84%
And the TSP LifeCycle Funds are very average for 2015 so far (just as they are engineered to be), ranging from 1.30% to 2.01%.
Last Month’s Economic Numbers:
I will run through the key indicator data I use in determining where I think we are in the economic cycle and what that data means to me in deciding how to allocate my Thrift Savings Plan balance (these indicators are explained in some detail in How to Determine the Current Phase of the Business Cycle).
First up, the US numbers:
Employment numbers: the November jobs numbers beat expectations both in jobs created as well as wage growth. I obtain this data from the Bureau of Labor Statistics:
Unemployment rate in the US was recorded at 5 percent in November 2015, the same as in the previous month and the lowest in more than seven years, while total nonfarm payroll employment increased by a higher-than-expected 211,000. Job gains occurred in construction, professional and technical services, and health care. Mining and information lost jobs.
At this point we are at full employment and really can’t expect huge new jobs numbers each month. Instead, economists will look at more nuanced data such as wage growth and number of workers reentering the workforce to try to figure out if things are going in the right direction.
Purchasing Managers’ Index (PMI): as usual, I pulled up the most recent report from the Institute for Supply Management. Any number above 50 indicates economic growth, and this month’s reading of 48.6 is below that range, but just barely. It is worth noting it is the lowest number we have seen in more than a year and it has been trending in the wrong direction, but I think this may have had more to do with the timing of the survey on the day after the Paris attacks than real economic concerns:
Manufacturing contracted in November as the PMI registered 48.6 percent, a decrease of 1.5 percentage points from the October reading of 50.1 percent, indicating contraction in manufacturing for the first time since November 2012 when the PMI® registered 48.9 percent. A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.
A PMI above 43.1 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the November PMI indicates growth for the 78th consecutive month in the overall economy, while indicating contraction in the manufacturing sector for the first time in 36 months. The past relationship between the PMI and the overall economy indicates that the average PMI for January through November (51.7 percent) corresponds to a 2.7 percent increase in real gross domestic product (GDP) on an annualized basis. In addition, if the PMI for November (48.6 percent) is annualized, it corresponds to a 1.7 percent increase in real GDP annually.
Yield spreads: The Cleveland Fed has resumed publishing their yield curve and recession probability piece. They place the probability of a US recession based on the yield curve in the next year at 3.74%:
Money supply growth rate: Money Supply M2 (which includes savings deposits, money market mutual funds and other time deposits which can be quickly converted into cash or checking deposits) increased nicely from October to November. The growth rate is what is meaningful here, so the picture below showing the jump after the flattening between September and October is what gives us confidence that this indicator is moving in the right direction:
Money Supply M2 in the United States increased to 12288.10 USD Billion in November from 12200.40 USD Billion in October of 2015.
TSP S Fund Conclusion:
All of the indicators are still pointing in the same direction. I believe that we are between the Recovery phase and the Growth/Prosperity phase of the Business Cycle for all of the reasons which I described in my earlier post on The Business Cycle Theory of Investing, and that the chances of the US economy entering recession anytime soon are very low. For that reason, I remain 85% invested in the TSP S Fund (but only for another few days). You will recall that the Growth/Prosperity phase is characterized by full employment and rising interest rates, both of which we have recently achieved. Because I think we are still in the grey area between phases, I would be just as comfortable with any mix of the S Fund and C Fund for that 85% of my allocation. And in fact, if I didn’t hold a very sizable percentage of my non-TSP assets in C Fund equivalents (S&P 500 funds), I would have almost certainly moved perhaps 40% to the C Fund by now. This is not to say that I believe the S Fund and C Fund will perform on par with each other, just that I don’t believe the business cycle theory of investing gives us strong guidance in either direction at this point, and when in doubt I tend to prefer the S Fund as it tends to outperform the C Fund by a larger margin when it does well than the C Fund outperforms the S Fund. All that said, I suspect that I will start moving my Thrift Savings Plan into the C Fund next week and will be completely moved across by the middle of 2016.
The TSP I Fund:
I currently have 15% of my Thrift Savings Plan allocated to the TSP I Fund. You will recall that when we talk about the I Fund, 70% of it is made up of large cap stocks from Japan, the UK, Germany, France and Switzerland:
It isn’t nearly as simple to look at all of the constituent bits of the TSP I Fund as it is to look at the US economy and draw a conclusion as to where they average out to be in their respective economic cycles. But we can try to get a close approximation by looking at the key economic indicators for the big five players in that universe. Note that there is not necessarily as strong a correlation between these indicators and growth in each of these countries as there is in the US. I’m not going to go into detail on each one, but I will include a link to the Trading Economics country summary pages which is what I rely on for a snapshot. As I look at these, I tend to focus on GDP growth rate, Unemployment, Money Supply Growth, and PMI:
- Japan: Japan indicators summary page
- United Kingdom: UK indicators summary page
- France: France indicators summary page
- Switzerland: Switzerland indicators summary page
- Germany: Germany indicators summary page
And after looking at those numbers and factoring in the stimulus efforts of both the European Central Bank and Japan, I’m comfortable with allocating a portion of my Thrift Savings Plan to the TSP I Fund.
First up, the 2016 FERS Guide is out now. I am not affiliated with the FERS Guide in any way (although the TSP Allocation Guide is listed as a recommended resource in it) and I don’t get anything for recommending it, but it is an amazing resource and worth much more than the $10 it costs. Dan Jamison has been working on this 100 odd page guide for decades and it includes everything you need to know about the Federal Employee Retirement System. New employees should read this cover to cover during their first week on the job and then once a year thereafter: www.fersguide.com
And second, an excellent book which I had heard about but had never put my hands on until this month: The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor by Howard Marks. Marks is the chairman and cofounder of Oaktree Capital Management and anticipation for his client notes has almost reached the level of that for Warren Buffett’s annual letter to shareholders. Buffett himself is a fan, saying “When I see memos from Howard Marks in my mail, they’re the first thing I open and read. I always learn something, and that goes double for his book.”
The Next Update
I will be busy the next couple of weeks and will knock out a ‘look back at 2015’ and a ‘look forward at 2016’, as well as a post on my non-TSP investing (which went much better than my TSP investing this year). I send out a notification of these updates (or allocation changes during the month) to the email list which you can subscribe to here: Subscribe. If you want to see what I am reading throughout the month, I also have a twitter account to which I usually post items of interest which I have stumbled across for investors, Feds and the military about once a day at: @TSPallocation
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