TSP 101

Risk managing your TSP portfolio means allocating your hard-earned money to five funds:

C Fund: S&P 500. The king of the indexes, what most people mean when they say "the market." The most prominent ETFs include SPY, IVV, VOO, and SPLG.
S Fund: Dow Jones U.S. Completion Total Stock Market Index. Includes about 3,500 small and mid cap stocks not included in the S&P 500. The only ETF I have found that tracks this index is VXF.
I Fund: MSCI ACWI IMI ex USA ex China ex Hong Kong Index, which means MSCI All Country World Index Investable Market Index. Includes about 5,500 companies or 99% of the companies (ex USA, China, Hong Kong). The best ETF proxy I have found to track this index is ACWX, which includes China and Hong Kong.
F Fund: Bloomberg U.S. Aggregate Bond Index. Includes short-, medium-, and long-term U.S. Treasury Bonds (44%), Mortgage Backed Securities (25%), Investment Grade Corporate Bonds (25%), and other bonds (6%). The most prominent ETFs include AGG, BND, and SPAB.
G Fund: Cash. Unique to the TSP. Risk-free like cash, meaning the principal can never decline, but the interest rate is a weighted average of Treasury securities with maturities of 4 years or longer.

As you can see, with only five funds, the TSP allows you to own most of "the market," with the exception of certain bonds and commodities. The growth of your portfolio will depend on capital gains (stocks and bonds), dividends (stocks), and interest payments (bonds). This leaves you with three options for managing risk, which we will define as the potential for significant loss and long-term or irreparable harm:

Fixed Portfolio: This includes the 60/40 portfolio -- our benchmark. The challenge here is adjusting the allocations on a regular basis (e.g., quarterly) to maintain the 60/40 ratio -- your risk management tool. For example, if stocks over perform and bonds under perform during the quarter, you have to sell stocks and buy bonds to reset the 60/40 ratio. If you don't and allow the portfolio to drift to 70/30 or 50/50, your risk profile will change as well.
Lifecycle Portfolio: Portfolio allocations adjust automatically over time based on your retirement date. This turnkey approach eliminates the need for you to adjust your portfolio, but the allocations are based on an arbitrary date, not on underlying market conditions. Not to mention, gradually shifting to cash and bonds over time doesn't necessarily lower your risk, especially if inflation returns or we see a secular bear market in bonds.
Economic Cycle Portfolio: In this case, we adjust our portfolio allocations over time to reflect where we are in the economic cycle. If the economy is chugging along, stocks will outperform and bonds will lose value when the Fed hikes rates to restrain growth. If the economy is weakening, bonds will outperform as the Fed cuts rates and stocks will lose value as profits decline. Timing the market is not easy, but there's a lot of data available for tracking where we are in the economic cycle.

Join now and receive FREE access until 2025!

In addition to the five TSP funds, you can also allocate up to 25% of your portfolio to mutual funds. There are thousands of mutual funds, to include some low-fee options that provide upside potential and diversification (see our newsletter). Most important, why add mutual funds to your portfolio?

Sector Rotation: The S&P 500 (C Fund) consists of 11 sectors (Technology, Financials, Energy, etc.), that outperform during different phases of the economic cycle. We can reduce our exposure to C Fund to add outperforming sectors.
Region Rotation: I Fund consists of regions (Europe, Asia, Latin America) that outperform during different phases of the economic cycle. We can reduce our exposure to I Fund to add outperforming regions.
Bond Rotation: F Fund includes major bond types (Treasury, Corporate, MBS) and tenors (short-, medium-, and long-term) in one package, but doesn't include TIPS, High Yield, or individual tenors. We can reduce our exposure to F Fund to add outperforming bonds. If the economy enters a recession, bond positions will be key for managing risk.
Themes: Missing from the TSP is exposure to gold, commodities, real estate, or other themes. These tend to have a lower correlation to stocks and bonds and therefore improve portfolio diversification.

Most mutual funds have higher fees than TSP funds, such as 0.50% versus 0.05%. This might seem like a big difference, but for a $5,000 position, the difference is $25 versus $2.50 for one year, or half if we hold the position for six months. And, all the mutual funds pay dividends or interest that far exceed these fees. Not to mention, we wouldn't add a mutual fund unless we thought it would outperform the TSP funds. By limiting our mutual funds to one company (see our newsletter), we cut trading fees in half (sell one and buy another for one fee). Finally, we list the ETF equivalent for each mutual fund, which allows you to diversify your portfolio by buying ETFs in your other accounts (IRA, brokerage, etc.).

As we manage our portfolio during the economic cycle, we should consider the following risks:

Market/Systematic Risk: The risk of asset prices falling due to events that trigger selling, which is relevant for C, S, I, and F Funds. This risk cannot be diversified away, but can be hedged with downside protection, such as G Fund.
Currency/Political Risk: The risk of foreign stocks or bonds falling due to the changing value of the underlying currency, or to political events, which is relevant for I Fund.
Inflation Risk: The risk that your investments don't grow fast enough to offset inflation, which is relevant for all five funds, and the only one relevant for G Fund. If an investment grows 10% in nominal terms during the past year but inflation rises 15% (-5% real return), your purchasing power has decreased.
Credit Risk: The risk for bondholders (F Fund) when borrowers default. Treasury Bonds don't have credit risk, in theory, because the government can issue new debt or print money to meet its obligations, but you could see defaults with corporate bonds or mortgage-backed securities (MBS).

Membership

TSP 101

NAVIGATE

CONTACT