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).
- open and fund a traditional IRA (select non-deductible on the form)
- once the account is funded, convert the new IRA account to a Roth IRA by submitting the brokerage’s form or calling customer support
- 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.
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:
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!