TSP Investing in 2018

2018 Road Ahead for TSP Investors

Happy New Year!

First things first: I have changed my TSP allocation (and transferred existing balances) to 50% C Fund, 50% I Fund. More on that below.

In this post I will run through a few of the investing rituals I go through at the beginning of every year, take a quick look back at 2017, explain why I am making the allocation change, and talk about the risks and potential for the year ahead.

In the next few days, I hope to get out additional posts about (1) what I will be investing outside of the TSP this year and (2) my recent adventures in crytocurrency speculation.

I am going to try to be a bit less verbose this year and keep these posts to a more manageable size. That will help readers get through them, and will make it more likely that I will get them out on time (particularly as we get closer to the baby arriving). If you find that means I have skimped on detail and you have questions, please don’t hesitate to ask in the comments or on the message board.

And before we get into the substance, thanks very much to all of you who helped the website and community grow in 2017 by sharing with your colleagues, sending me suggestions and making donations to defray expenses.

Tasks for the New Year

Adjust TSP contributions: Top of the list was adjusting bi-weekly TSP contributions on the TSP.gov website to maximize matching and make sure I am able to invest the full amount. The annual limit was raised by $500 to $18,500 for 2018. There is no one-size-fits-all number to maximize contributions because there are either 26 or 27 pay dates in 2018, depending one which processor services your agency:

NFC: 27 pay dates = $686
Interior: 27 pay dates = $686
GSA: 26 pay dates = $712
DFAS: 26 pay dates = $712

Back-door ROTH IRA: Next up was opening a back-door Roth IRA to continue to put as many of my investments into tax-advantaged accounts as possible. (Please don’t confuse this investment account which is completely separate from the TSP with the TSP Roth option). In many respects, a Roth IRA is a better vehicle for your money once you have contributed enough to your TSP to capture all the employer matching you are eligible for. (Of course if you make less than $120,000 for single filers and $189,000 for married couples filing jointly, you can skip the back-door part of this and just open a Roth IRA directly.)

It sounds complicated, but if you already have a brokerage or Vanguard account it will take about 15 minutes from start to finish. (If you don’t already have investment accounts outside the TSP, I strongly recommend Vanguard.com).

  1. open and fund a traditional IRA (select non-deductible on the form)
  2. once the account is funded, convert the new IRA account to a Roth IRA by submitting the brokerage’s form or calling customer support
  3. result: you now have $5500 to invest on which you will pay no taxes on gains, you can withdraw your principal (the $5500) at any time with no penalty, and you can withdraw gains prior to age 59 1/2 to buy a home or for higher education expenses (which is why you always fund your Roth IRA before a 529 account).

If you have the money to do it, you can also still do the same thing for tax year 2017 until April 15, 2018, so you can get your Roth off to a five-figure start.

*Note that if you have existing traditional IRAs which were funded with pre-tax money (deductible), this probably isn’t for you. See the comments and link below. (Thanks Steve!)

A Quick Look Back at the TSP in 2017

First, let’s take a quick look back at 2017. I can’t take credit for it, but I am pretty happy with the way things went:

C Fund: 21.82%
S Fund: 18.22%
I Fund: 25.42%
F Fund: 3.82%
G Fund: 2.33%

If you look back at last year’s post (A Look Forward at TSP Investing in 2017), you will see that I got a few things right (the C Fund outperforming all of the other domestic funds, the US avoiding recession, and the circus in Washington, DC not having a real impact on the stock market). And a few things wrong (the market grew much more strongly than the “mid-to-high single digit returns” I predicted, we saw a lot less volatility than I expected, and the TSP I Fund didn’t fall apart as a result of the UK’s vote to exit the EU).

In my defense, I did say in last year’s post that I thought the I Fund could potentially perform as well or better than the C Fund, but that their valuations were similar so the added risk didn’t make sense to me.

But I’m not really feeling defensive – last year turned out pretty well.

An interesting aside about that 21.8% return for the C Fund – that is almost exactly the average return of 21.5% for the S&P 500 in bull market years. We all know by heart that the S&P 500’s average annual return is about 10%, so we make that our benchmark and predict slightly higher for good years and slightly lower for bad years. I do it too. But that isn’t at all what has happened historically – we should expect much, much higher returns in bull market years, and much, much lower returns in bear market years. And that’s why it is so important to be out of the market for as many of those bear markets as we can.

A Look Forward at 2018

The stock market goes up two years out of three. Eliminate the years when the US is in recession and it gets much better than that. All indications are that the US and other developed markets will avoid recession in 2018.

Without a recession, the stock market will in all likelihood end the year higher than where it started. As with last year, from a price to earnings ratio perspective, right now the US stock market doesn’t have a lot of room to grow (meaning the market’s current P/E is well above average), so it is hard to imagine that we will do as well as we did last year. But that’s what I said last year and the market powered right through those worries. The corporate tax cut could give a little bit of relief to those high valuations as that gets factored into earnings over the next few quarters.

I certainly expect that we will see more volatility this year than we did last, which was extraordinarily smooth. It is almost as if so many outrageous things happened in 2017 that nothing mattered and everything which typically would have caused the typical 5-10% declines was ignored.

As at the beginning of every year, I will confidently predict we will see four or five 5% corrections, and probably a 10% correction at some point (because that happens pretty much every year). With history as a guide, I am convinced the timing of those corrections isn’t predictable, and that the market will recover and move higher in each case within a matter of weeks. In 75% of years in which the market goes up, the market drops below break-even during the first quarter.

So with all of that together, I think there is an excellent chance we will see a 5% to 10% correction at some point in the next two months. But I won’t try to game that – if I held money out and waited for a drop, the market would inevitably go on a strong run and leave me behind.

Risks to the TSP Stock Funds in 2018

Trump dominates all talk of risks to the global economy right now with his rhetoric on trade, particularly with attacks on China (our #1 trade partner) and NAFTA (our #2 trade partner (Canada) and #3 trade partner (Mexico)). But the markets appear to be tuning the posturing out and looking at the actions coming out of DC. Or rather the inaction – while the US withdrew from talks for the Trans-Pacific Partnership, it hasn’t touched any of the existing trade agreements we have in place. Imports from China increased by $32 billion in 2017, and imports from Mexico and Canada soared as well.

It is certainly possible that the administration will slap tariffs on a few Chinese products to rally the base or benefit a favored industry, but the stock market is the one thing they can really point to as a success amidst all the other turmoil, so I don’t think it is likely they will take a chance on putting a stick into the spokes by pursuing real change in that area.

So which TSP fund?

I believe the I Fund is going to be the strongest performing fund in 2018 on the back of Europe (minus the UK) and Japan for the following reasons:

  • Dramatically cheaper relative valuations (C Fund is at 22.87, I Fund is at 16.75)
  • In contrast to the US, Europe is earlier in their recovery, economic expansion is accelerating, and unemployment has room to fall.
  • Supportive central bank policies – the ECB says monetary stimulus will continue until at least September and the Bank of Japan appears unlikely to change targets until 2019, whereas the US Federal Reserve is actively raising interest rates.
  • Declining political uncertainty in Europe, both within countries as well as internationally on the Brexit front is leading to greater business and investor optimism.
  • A very competitive euro helping exports.

On the domestic side of the house, large cap stocks (the TSP C Fund) will typically outperform small and medium cap stocks (the TSP S Fund) at this stage in the business cycle. Last year I got into a long discussion about the relative valuations of the C Fund and S Fund before making the decision to stick with that historical trend, but right now the weighted average P/E ratios of the C Fund and S Fund are within 0.4% of each other so that is not a factor.

Small and medium sized companies may benefit somewhat disproportionately from the tax bill because they are actually paying something close to the listed tax rate, whereas the effective rate of the huge multinationals which make up much of the TSP C Fund is much lower. But I don’t see that potential advantage outweighing the large cap’s historical outperformance in this phase of the business cycle.

It’s also worth noting that I have a sizable share of small/mid-cap ETFs in my other investment accounts, so S Fund equivalents are well represented in my overall portfolio if they do take off. Everyone’s circumstances are different, so someone who doesn’t have exposure to that sector of the market might put more thought into allocating some of their allocation to the S Fund than I did. Even if I didn’t own those S Fund equivalents, however, I would probably not be in the S Fund right now – I don’t still own these small cap funds because I think they will outperform large caps, but rather because they are in regular (non-tax advantaged) accounts and if I sell them I am going to have to pay a lot of taxes on my gains.

Conclusion: I believe that the I Fund will outperform the C Fund over the next twelve months, but not with enough conviction to go to 100% I Fund. When I was younger I might well have gone all-in on the I Fund in these circumstances, but perhaps I am feeling a bit conservative under the weight of impending parenthood and so have set my TSP contributions and conducted an inter fund transfer of existing balances to 50% C Fund, 50% I Fund.

Please don’t ever forget that these allocations are based on my circumstances and the strategy which I have chosen to employ. Your circumstances may be very different and my strategy may not work, so I encourage everyone to read widely and consider a range of different viewpoints before making investing decisions for themselves.

Recommended Reading

If one of your New Year’s resolutions is to get serious about making smart investing decisions, the following are the three essential books I would recommend:

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

A Random Walk down Wall Street: The Time-tested Strategy for Successful Investing

The Most Important Thing Illuminated: Uncommon Sense for the Thoughtful Investor (Columbia Business School Publishing)

Coming Up

In my next posts I will find some time to talk about how I see investing outside the TSP in the coming year as well as discuss my recent limited foray into cryptocurrency gambling.

In the meantime, I don’t ask anything except that you share the site with your colleagues so we can continue to expand the community of feds and service members helping each other in a free, transparent, no-pressure environment (although if you want to, you can donate to support the site here). You can help by telling the person sitting next to you, linking to this site from your own webpage or blog, liking it on Facebook, sharing on Twitter and in other investing forums, or actively participating on our Message Board. So if you found this post useful, please share it with your friends and colleagues using the email and social sharing buttons below right now. Thanks!

39 thoughts on “TSP Investing in 2018”

  1. Excellent. I had already moved 20 percent into the I fund and I am glad to see you confirm what I have been hearing from many of the experts out there. Thanks so much for posting these, . I have learned so much just in the past month from here and elsewhere. Have a happy new year and congratulations on the upcoming baby.

  2. I’ve followed you for about 5 years and you have a very logical approach to the TSP and you’ve been mostly correct which isn’t easy.

  3. Moved from 100% in C to 50% C and 50% I as you have recommended. From inception until around 2014 the I fund was worth more than the C fund and many times more than the S fund.

    I am hoping it will make up some ground this year. Great site.

  4. Thanks Paul. You confirm what I’ve read elsewhere. You allude to the phase/stage of the business cycle without mentioning what you think it is. Have we changed stages, or are we about to. I’m reading some pundit thoughts that indicate we may be moving into the late phase. Thanks.

  5. Paul, I really enjoy your website. Got a question. In your post you state “a Roth IRA is a better vehicle for your money once you have contributed enough to your TSP to capture all the employer matching you are eligible for.” So if I get 5% matching, I should only contribute 5% of my salary to TSP? And then put money, $5500 max let’s say, in a Roth IRA?

    1. In some situations that might make sense. TSP has super low fees, but a Roth has virtually unlimited investment options and more flexibility for withdrawals for qualified purposes. I’m glad I have both.

  6. Paul, you correctly described the backdoor Roth process, but anyone contemplating the execution of this process needs to be aware that there is a major item that must be considered first. It deals with Internal Revenue Code Section 408(d)(2), the IRA aggregation rule. When determining the tax consequences of an IRA distribution, including to a Roth IRA, the value of all existing pre-tax IRA accounts will be aggregated together for the purpose of any tax calculations. This may severely limit the amount of money that is actually converted tax-free. Articles with examples of what could happen are available online. For anyone with existing money in pre-tax IRAs, please use due diligence.

      1. Paul, the basis for how much of the nondeductible transfer to the Roth IRA that will not be taxed factors in the total amount of money in all IRAs that an individual owns except existing Roth IRAs. If I have $100,000 in existing traditional IRAs and backdoor $5500 of nondeductible money, the basis is $105,500. An article by Adam Bergman in Forbes provides a great example of this. If you don’t trust the link, just google “backdoor Roth Forbes”. The article was published on October 16, 2017. I almost made this mistake, Would hate to see people incur extra taxes on retirement money. Also, take a look at IRS Form 8606 and look at line 6. Notice the word “all” is in bold letters. https://www.forbes.com/sites/greatspeculations/2017/10/16/factors-to-consider-when-contemplating-a-backdoor-roth-ira/#1d638b59f4ca

        1. Sorry Steve – I completely missed your point in the first comment. I didn’t have existing Traditional IRAs with deductible contributions when I started doing the Roth conversions, so I have never looked that aspect and it didn’t occur to me to address it in the post. I will add a note up above to make sure that anyone in that situation is aware of the issue. Thanks very much for the explanation!

  7. Thanks for what you do! I have the money to fully fund my back door Roth IRA and thinking about whether I do it in lump sum (I do that most years to maximize the time my money is working) or dollar cost average this year (since this year could be up and down – I agree with you on that). Thoughts?

  8. Paul,

    Would you say, generally, it is better to strive to max contributions to the normal TSP or reduce contributions by $5,500 and fund a Roth IRA.

    And if that is a good idea, why not just reduce normal TSP and fund Roth TSP?

    1. A fair number of people do just that for the flexibility provided by the Roth both for investment options and withdrawal options. I like having both and if I couldn’t max both out, I would seriously consider putting some of my money into a Roth after I made sure I was getting my full matching.

  9. I’m fairly new to this site but I must say, since I’ve been reading and switched to 100% C fund it has made a huge difference 🙂 My question is, when you change allocations do you always transfer existing balances as well?

  10. Thank you for all the work you’ve put into this site, and your clear writing and explanations. Business cycle investing is a new paradigm for me, one that really makes sense. Re: large cap stocks, what are your thoughts on growth vs value for 2018? Thanks!

    1. That’s not something I have really looked at recently, but a Morgan Stanley guy I follow and typically agree with on most things says that there should be a tilt towards value, FWIW.

  11. When you set allocation 50% I and 50% C, do you also do interfund transfer to rebalance the account or do you only adjust for future contributions and leave current balances as is.

    1. I do match existing balances to contributions. And if the balances ever get too out of wack, I will go back every six months or so and rebalance again.

  12. Hey Paul. Your site was recommended to me about a year ago and I became a fan after reading a few articles. I have only just started getting serious about dumping into my TSP but have been playing around in my IRA conservatively for years. Thanks to your advice and my growing TSP I feel more confident about my IRA “risks.” I still feel young so I will jump in at 25/75 C/I ratio. Thanks for the articles!

  13. Hi Paul,

    I currently have 2 TSP accounts one Military and one Civilian. My military one I moved 100% into I fund with 100% contributions there as well (Reservist). My civilian account I went a bit more aggressive then you recommended in this article with 75% into I fund. 11% into C fund and 14% into L 2050 fund. I have not Hit my first 10 years of civil service so I feel that I can be far more aggressive with going to I fund compared to your recommendations. Do you think I am wasting time and funds on purchasing L fund shares? Or should I put that money into C and I. Thanks for the work you do!

    1. Definitely don’t make any decisions based on what I think, but I just haven’t had any use for LifeCycle Funds. I wont want to own the G Fund or F Fund in a period in which I believe the stock market is likely to go up, so that hedge doesn’t hold any appeal for me.

  14. Hi Paul!

    New subscriber here! I am curious, I don’t make enough to deposit maximum tsp contributions, I have 10% of each paycheck being deposited into a traditional TSP which accounts for about $640/month. Should I actually be doing 10% of each paycheck into my Roth TSP? Or do we not get matching contributions unless it’s deposited into the traditional TSP?

    I also have a 529 for my son with USAA, you’re saying I should instead roll this money over to a Roth IRA?

    Thank you!

    Nicole Carrier-Theulen

  15. Paul, awesome write up I agree 50% into C Fund and 50% into I fund, I gave it some thought and towards the last part of your article where it says that you are going to be more conservative because of upcoming parenthood and if you were younger you would go all in 100% into I Fund… I went aggressive and did 100% into I Fund with 100% interfund transfer to I Fund. do you think that is wise or should I stick with my gut and also your statement of 50% C Fund and 50% I Fund?

  16. Hi Paul,

    Wow, what a great site and thanks very much. Your work is much appreciated. I’m a few years from retirement so maybe a bit aggressive (for my sanity), but I know deep down your allocation is probably correct. I had 100% C Fund from 1992-2010. I just need to ease back to 80-85% equities for now, but your guidance is very helpful and will distribute to C and I.

    Steve

  17. Hey Paul,
    Awesome advise! I found your webpage by total accident and really glad I did. I’m 34 and have just started my civilian Federal job. I’m as miltech so I’m also a reservist. Have you had a chance to see anything on the new Blended Retirement for service members now? biggest thing is the TSP is going to do the same as the civilian side, making up to 5%. I plan on being in the federal system as long as they will keep me! I’m in the grey area where I have a do or die decision to make. The civilian side I’m WL9 in the DC area so my TSP is covered on that end. the Army on the other hand I have a lot more growth to go and feel the high 3 legacy won’t give me nearly as much as the BRS would even with the .5% change in retirement. What are your thoughts on that?

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