THE IMPORTANCE OF INDIVIDUAL FUNDS MANAGEMENT
WITHIN A FEDERAL RETIREMENT SYSTEM
Why and How to Structure Your Own
Personal Investment Program
--An Off-the-shelf Example--
The system referred to is the TSP (Thrift Savings Plan) administered by the Federal Retirement Thrift Investment Board for the benefit of government employees and military personnel. It was established by Congress in 1986. Its purpose is to provide retirement income. It is the best general retirement funding plan, public or private, the author has ever come across, bar none. Unless you are a federal employee or member of the armed services, you are unlikely to have heard of it. But it may have application to your needs as a parallel investment system.
Plan design and adoption show superb architectural and legislative intelligence. It is simple, but complete. There are five funds to choose from. They are broad and diverse. There are no flaws that would oblige its revision or abolition. The Plan is highly flexible but with strong safeguards against participant error or abuse. Its management costs are low. It gives the individual the exclusive right to choose and manage for the level of future wealth that he or she desires. It is easy to use. There are no transaction fees. In short, it is the best single, in my opinion, financial program in the lexicon of federal law to contribute to and strengthen the fiscal profile of the United States and the enjoyment of life for its participants.
How much wealth is possible? This simple table gives you some idea of what a single lump-sum contribution is worth over time compounded at the average rate of return of the example to be discussed below.
PROJECTED WEALTH COMPARISON
Best TSP Funds vs
Example System
Dollars
Hypothetical
|
Years |
G |
S |
System |
|
start |
10,000 |
10,000 |
10,000 |
|
5 |
12,300 |
15,016 |
22,830 |
|
10 |
15,130 |
22,549 |
52,123 |
|
15 |
18,610 |
33,860 |
118,998 |
|
20 |
22,891 |
50,845 |
271,678 |
|
25 |
28,156 |
76,350 |
620,251 |
|
30 |
34,632 |
114,649 |
1,416,058 |
Fund G is the TSP government securities fund.
It is a 'best' fund because it can never have losses.
All the others can and do.
S is the TSP small cap fund.
It a 'best' because it has produced
the most wealth of all TSP funds to date.
System is the subject funds-management example.
It produces more than 10 times the wealth
of the
best-fund selection in TSP to date.
How does it do this? A combination of two indispensable processes. One, by investing in the 'strongest' fund continuously and switching promptly to the next fund that emerges as the strongest of the group. Two, and even more indispensably, by autoimmunizing the portfolio against any bear market before it gains traction.
The sole data input in these two processes are prices. The price behavior of each fund determines its own rank standing compared with the rank standings of the others. Taken as group, the prices of all disclose the arrival and departure of bear markets thereby allowing the account holder to autoimmunize the portfolio by shifting all assets to Fund G for the duration of the bear. You can see these take place in the chart below at the bottom of the page.
Here is a comparison of the results of active fund management over the past seven years. It shows total gains nearly three times greater than the comparable gain from the best TSP fund, Fund S. The worst drawdowns for the TSP funds are severely damaging. The worst drawdown for the Example System is very shallow by comparison and has lasted only two months compared with a duration of 17 months for each of the other funds--so far.
A drawdown is how far a fund's prices drop before the next new high which exceeds the previous high from which the drop started. Note that the drawdowns for all three of TSP's equity funds are still open. They are technically not drawdowns until the prior top price is exceeded. This has not happened yet. These current drawdowns can get deeper if a succeeding, new down leg of the current bear market ensues.
RETURN and RISK COMPARISON
TSP Funds vs
Example System
Hypothetical
Seven Years 2002-2009
Statistics & Notes below
|
|
total |
%/ |
worst |
dur |
|
Fund |
type |
% gain |
year |
%dd |
mos |
|
S |
small cap |
80 |
8.5 |
-57.7 |
17 |
|
I |
internatl |
72 |
7.8 |
-61.6 |
17 |
|
C |
big cap |
26 |
3.3 |
-56.2 |
17 |
|
G |
Trsy income |
35 |
4.2 |
-0- |
-- |
|
System |
variable |
228 |
18.0 |
-8.0 |
2 |
For example, in the first row, the best performer of the group is Fund S, small stocks. It had a total per cent gain of 80% over the seven-year period, which is a compound return rate of 8.5% per year. Its worst drawdown was -57.7% and lasted 17 months to date. And so on down the line. The Example System total gain was 228%, a compound rate of return 18% per year. Its worst-case drawdown was -8% lasting 2 months.
System Statistics
Compound average return 18.0% per year
No loss years
Average holding period 20 weeks
Average profit per trade 10.0%
Average loss per trade -2.4%
Win/Lose ratio 3.4 to 1
Profit factor 11.62
Biggest win 7.5%
Largest loss -6.1%
Worst drawdown -8.0%
Average 3 switches per year
Longest single switch 18 months
(G Fund during bear market)
Next longest, 15 months (S Fund)
You may have noticed that there is no F Fund. The omission is deliberate. I did test runs including F. It detracted from cumulative results. That confirmed my decision to exclude it. The basic reason is twofold. Inflation will devastate bondholders' wealth. No government has any motive to cure inflation because the government will continually be able to pay interest and redeem bonds with cheaper and cheaper dollars. In other words, it taxes current dollars but pays off debt with deflated dollars. G Fund avoids at least part of this problem for the TSP participant. The interest income G pays varies with the issuance of new government debt at new interest rates and the retirement of old debt at old interest rates. The participant has the advantage of guaranteed variable income--in itself an inflation hedge--backed by a fixed guarantee to pay as long as there is Treasury debt. When assets are moved out of G the participant gets exactly the amount initially deposited without change in the initial value of the deposit.
The same reasoning applies to the L Funds (Lifecycle Funds) in TSP, which rebalance based on the number of target years remaining to retirement. Though L Funds diminish the bad effects of bonds as one gets closer to retirement age, they do not eliminate them. I would avoid them entirely. I know an octogenarian who owns only stocks or Treasury bills. He invests the same way a 30-year would (or should): safety first, then maximum return. His diversificaton is horizontal--across time--rather than vertical--owning a list of multiple funds or stocks. The market doesn't know how old you are. You don't know how long you will live after you are supposed to die.
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EXAMPLE SYSTEM
CHART ILLUSTRATION OF HISTORICAL TESTING RECORD
Based on Selection & Timing of TSP Funds
7.2 years--October 18, 2002--December 31, 2009
Hypothetical
Reading the Chart. All funds start with a value of 100. At the end, their values have increased to the amounts shown. All funds except the Example System and G Fund have market counterparts available to the public. (F Fund's counterpart symbol is AGG. C Fund's generic symbol is SPX (S&P 500 Index) or any of its specific equivalents.
Additional applications within and outside TSP. If there is enough interest, I can develop this 'example system' into an end product for general release to TSP participants and other, outside investors. The subscription cost would be in line with those already posted on the website. Please send an email here if you are interested.
Notes. More on method here to which has been added the latest in timing methodology from our research lab. An article and table on the failure and real losses of U.S. Treasury bonds (and corporates) in a pension-fund environment are here. The proxy used for the TSP G Fund is the 10-Year Treasury Constant Maturity Rate (source: Federal Reserve Bank of St. Louis). The coefficient of correlation is 0.9806; the eight-year final wealth results are nearly identical, a difference between the two of 0.02% greater wealth in the G Fund.
Acknowledgements. I owe writing this article to a suggestion from one of my subscribers to the website. Many thanks to him and others who have commented on my treatment of TSP.
~Copernicus
John P. Meehan
5/2/2010 6:07 p.m. EDT
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