A Look Back at the Business Cycle TSP Strategy in 2014

bull fighter Thrift Savings PlanI remained in the Thrift Savings Plan’s S Fund for the entirety of 2014, resulting in a return of 7.80%. That’s not a bad number – most financial advisors these days will tell you that you should plan to average between 6% and 8% per year – but lower than we have become accustomed to in the heady days of the current bull market. The TSP S Fund compared favorably with the G Fund (2.31%), F Fund (6.73%), I Fund (-5.27%), and all of the TSP LifeCycle Funds (which ranged from 3.77 to 6.37%). But it trailed the TSP C Fund (13.78%) significantly, raising two questions: (1) was I invested in the wrong fund for some or all of the year, and (2) if not, is there a way to tweak the business cycle investing strategy to improve performance in years like 2014?

As I look back, there was never a time in 2014 when I didn’t feel that the US economy was still in the recovery phase of the business cycle. The historic numbers indicate the TSP S Fund typically outperforms the C Fund in that phase, so I believe my strategy was sound. This was not a typical year, however, and the market did not follow the numbers. The S fund was disproportionately hurt by the biotech correction early in the year, and then the rest of the year was characterized by the over performance of some unlikely sectors.  The market was led by utilities, healthcare and and consumer staples – all sectors which do not typically do well when GDP growth accelerates and unemployment falls during the recovery phase. So in my estimation, 2014 was an outlier.

Thrift Savings Plan - thinkerThe second question is trickier. I was aware as we entered 2014 that small cap stocks were very expensive relative to large caps as measured by aggregated P/E ratios, with a spread of 16% from the historical average. That is in part a reflection of where we are in the business cycle (small caps move further from their average during the recovery phase), and to some degree that relative expensiveness will not revert (come back to normal) until the phase changes. But that was a very wide spread. So on a theoretical level I believe I could be more aggressive and integrate sector P/E ratios as factor in my Thrift Savings Plan investing decisions – in the case of 2014 recognizing that the gap was much wider than normal and that it was likely to shrink.

But implementing a change in TSP investing strategy based on sector P/E ratios goes against the core of the business cycle strategy. It is, as I have said before, a buy and hold strategy with an occasional tweak to protect against major losses and to get a few extra percentage points in good years. One of the key benefits of using the business cycle strategy is its simplicity – it requires very little monitoring and changes are few and far between. In fact, I would be fairly confident in only really sitting down and looking at business cycle indicators quarterly – I do it monthly for the most part because I am writing this blog. In contrast, if I incorporate sector P/E’s into my TSP strategy, I would become a trader trying to time when those sectors will revert to their historical averages and be required to monitor those ratios on a regular basis.

My gut reaction is that I am better off spending that time looking for values in individual stocks or for the next big thing, or better yet with my family or outside away from the computer. But in the back of my mind, I am very curious as to whether I could significantly improve my TSP strategy, so I will take a closer look at sector P/E’s and add that to my discussions, if not my actual TSP investing, in 2015.

As we start the New Year, the two domestic sectors which are most “undervalued” are large cap growth and small cap growth, and small caps overall are about 4% “overvalued” compared to large caps. Neither of these factors would really provide any direction to me in making my TSP investing decisions right now.

Non-TSP Investments

non-TSP investmentsI did better with my investments outside the Thrift Savings Plan in 2014 than I did in the TSP, with an overall return of 12% and dividend income approaching $1,000 per month. This was largely due to some fairly substantial large cap ETF holdings, the strong performance of some of the individual stocks which I hold (most notably large positions in Apple (40%), Berkshire Hathaway (45%) and FaceBook (42%)), and the good fortune that none of my individual investments went completely belly-up on me last year. Those were enough to swing the needle up from my otherwise heavy weighting of small cap ETFs and a few poor performers like Amazon (-22%) and Google (-5%).

Looking Forward to 2015

In my next post, I will share my views on the year ahead for TSP investors. I hope to get that out in the next day or two if life doesn’t interfere.

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