This is addressed to the members of this community who give out advice on TSP allocation strategies. This is a really important topic, and I think the community might be suffering under a status quo that maybe hasn't been challenged. This observation is just what I've seen over the past few months.
One of the most common topics I see here is TSP portfolio allocation. Just as common is the seemingly default response of 60/20/20 C/S/I. I’d like to go over this particular allocation, why it’s popular, when it is a good choice, and more importantly, when it is not a good choice. I’ll also discuss some other portfolio options.
So why did that particular portfolio and its sibling, 80/10/10 C/S/I, become so popular? It’s not necessarily from a clear superiority over other options, it’s mainly because Dave Ramsey recommended it a while ago. That doesn’t make it a bad portfolio, but it’s important to remember the basis of its popularity. One person’s opinion.
This portfolio is an all-stock portfolio. An all stock portfolio is considered very aggressive for a buy-and-hold investor. Proponents of all-equities-all-the-time argue that if investors simply stay the course, they will eventually recover those losses and earn much more. However, this assumes investors can stay the course and not abandon their strategy – meaning they must ignore the prevailing "wisdom," the resulting dire predictions and take absolutely no action in response to depressing market conditions. An investor with this portfolio needs to be able to face off a 40-50% drop in his portfolio value without flinching. It can be extremely difficult for most investors to maintain an out-of-favor strategy for six months, let alone a year. An all-stock investor needs a high tolerance for risk on a personal level, and a solid understanding of how and why the market cycles, if they are to hold on during a depression.
“I’ll just switch to the G fund for a short time until it looks like things are turning around, then I’ll catch it on the upswing”
“This time is different”
“Everyone is saying we have at least another 2-3 months of this.”
We all know about these perils and negative mindsets that take place, and we warn against them, because they happen all the heckin time during a crash. And if someone sells an all stock portfolio during a crash and abandons the buy-and-hold philosophy, than this is the absolute worst portfolio for them.
So most importantly, this portfolio needs to be within the risk tolerance of the investor. The investor needs to have the right personality and a solid base of investing knowledge. Let’s imagine a bell curve, with the mean point being a military member with average risk capacity, and an average amount of knowledge on how the stock market works (which isn’t much in the military, ask around your office about investing and you’ll find many people don’t know a thing). On the right side we have more risk-tolerant, intelligent investors. If I had to guess, and I’ll be generous, maybe the top 40% of investors are suited to this style portfolio. Which means that a majority of people should not be using this portfolio. Maybe you think I’m not giving our armed force enough credit, even if you wanted to say any military member with an average amount of risk capacity and average knowledge could effectively use this strategy, that still means the other half shouldn’t be using an all stock portfolio. So to recap if this portfolio doesn’t suit you right, it’s the worst possible portfolio. Most people aren’t suited to this portfolio. Therefore, it should not be the default recommendation.
Before recommending this portfolio, please ask about their risk tolerance, age, and tell them about buy-and-hold investing too when you do make the recommendation.
Now what about other options? Two things as a primer for what I'm about discuss, risk-adjusted return should be considered and balanced with pure return, and the small-cap premium is proven to be robust, timeless, and pervasive. Take a look at this
Portfolio 1 is the 60/20/20 C/S/I portfolio. This is all hindsight, but looking back from 1997-2018 (2 full market cycles, didn’t cherry pick this, it was just the age of the youngest fund on the list), it’s easy to improve or keep your desired return by tilting towards small cap more, and you can then improve your risk-adjusted return depending on how you play it. In the link, portfolio 3 even increases its international allocation during one of the worst periods of history for it, and still comes out ahead of the 60/20/20 in regards to CAGR, Stdev, Max Drawdown, Sharpe and Sortino ratios. Imagine how much better that would be if over the next 30 years we run into a decade where international stocks outperform or even keep pace with American stocks. Portfolio 2 finished just shy of the 60/20/20 CAGR, but has much lower volatility, and you would see 10% less drawdown during a bear market. It’s overall a much more diversified portfolio, fit for differing economic environments. A fourth portfolio of C/S/I/F 35/35/20/10 is just straight up a better in every measure over this time period as well.
And let’s talk about the I fund a little more. In r/porfolios, I’ve seen several times, people who work in the tech industry investing in tech sector funds. They are familiar with the industry, and they can imagine the role it will play in the future, and they want to tilt that way with their portfolio. By relying on the tech industry for their current income, and by relying on the tech industry for their future income, they are essentially doubling down on the tech sector to succeed. This is generally a mistake. You want to diversify, not concentrate. The same can be applied to us. Our livelihoods, pensions, healthcare, etc. depend on the economic growth of the U.S. That and it's been shown time and time again, that having a healthy international allocation improves risk-adjusted return. So hesitate just a moment before recommending doubling down on domestic.
TL;DR: Don’t be afraid of the F fund. It’s not going to zap your returns. Especially for those of you over 30. If someone has a high risk tolerance, they can consider capturing more of the small-cap premium instead of just going all stock. Most people only ever consider the C/S/I funds. That allows for 7 possible portfolios with varying percentages in each fund. If you keep in mind the F fund, you have 14 possible portfolio types. And don’t neglect the I fund.
If you all have different opinions or insights you'd like to bring up, I'd love to hear them I think this sub would greatly benefit from a discussion on portfolio allocation.
One of the most common topics I see here is TSP portfolio allocation. Just as common is the seemingly default response of 60/20/20 C/S/I. I’d like to go over this particular allocation, why it’s popular, when it is a good choice, and more importantly, when it is not a good choice. I’ll also discuss some other portfolio options.
So why did that particular portfolio and its sibling, 80/10/10 C/S/I, become so popular? It’s not necessarily from a clear superiority over other options, it’s mainly because Dave Ramsey recommended it a while ago. That doesn’t make it a bad portfolio, but it’s important to remember the basis of its popularity. One person’s opinion.
This portfolio is an all-stock portfolio. An all stock portfolio is considered very aggressive for a buy-and-hold investor. Proponents of all-equities-all-the-time argue that if investors simply stay the course, they will eventually recover those losses and earn much more. However, this assumes investors can stay the course and not abandon their strategy – meaning they must ignore the prevailing "wisdom," the resulting dire predictions and take absolutely no action in response to depressing market conditions. An investor with this portfolio needs to be able to face off a 40-50% drop in his portfolio value without flinching. It can be extremely difficult for most investors to maintain an out-of-favor strategy for six months, let alone a year. An all-stock investor needs a high tolerance for risk on a personal level, and a solid understanding of how and why the market cycles, if they are to hold on during a depression.
“I’ll just switch to the G fund for a short time until it looks like things are turning around, then I’ll catch it on the upswing”
“This time is different”
“Everyone is saying we have at least another 2-3 months of this.”
We all know about these perils and negative mindsets that take place, and we warn against them, because they happen all the heckin time during a crash. And if someone sells an all stock portfolio during a crash and abandons the buy-and-hold philosophy, than this is the absolute worst portfolio for them.
So most importantly, this portfolio needs to be within the risk tolerance of the investor. The investor needs to have the right personality and a solid base of investing knowledge. Let’s imagine a bell curve, with the mean point being a military member with average risk capacity, and an average amount of knowledge on how the stock market works (which isn’t much in the military, ask around your office about investing and you’ll find many people don’t know a thing). On the right side we have more risk-tolerant, intelligent investors. If I had to guess, and I’ll be generous, maybe the top 40% of investors are suited to this style portfolio. Which means that a majority of people should not be using this portfolio. Maybe you think I’m not giving our armed force enough credit, even if you wanted to say any military member with an average amount of risk capacity and average knowledge could effectively use this strategy, that still means the other half shouldn’t be using an all stock portfolio. So to recap if this portfolio doesn’t suit you right, it’s the worst possible portfolio. Most people aren’t suited to this portfolio. Therefore, it should not be the default recommendation.
Before recommending this portfolio, please ask about their risk tolerance, age, and tell them about buy-and-hold investing too when you do make the recommendation.
Now what about other options? Two things as a primer for what I'm about discuss, risk-adjusted return should be considered and balanced with pure return, and the small-cap premium is proven to be robust, timeless, and pervasive. Take a look at this
Portfolio 1 is the 60/20/20 C/S/I portfolio. This is all hindsight, but looking back from 1997-2018 (2 full market cycles, didn’t cherry pick this, it was just the age of the youngest fund on the list), it’s easy to improve or keep your desired return by tilting towards small cap more, and you can then improve your risk-adjusted return depending on how you play it. In the link, portfolio 3 even increases its international allocation during one of the worst periods of history for it, and still comes out ahead of the 60/20/20 in regards to CAGR, Stdev, Max Drawdown, Sharpe and Sortino ratios. Imagine how much better that would be if over the next 30 years we run into a decade where international stocks outperform or even keep pace with American stocks. Portfolio 2 finished just shy of the 60/20/20 CAGR, but has much lower volatility, and you would see 10% less drawdown during a bear market. It’s overall a much more diversified portfolio, fit for differing economic environments. A fourth portfolio of C/S/I/F 35/35/20/10 is just straight up a better in every measure over this time period as well.
And let’s talk about the I fund a little more. In r/porfolios, I’ve seen several times, people who work in the tech industry investing in tech sector funds. They are familiar with the industry, and they can imagine the role it will play in the future, and they want to tilt that way with their portfolio. By relying on the tech industry for their current income, and by relying on the tech industry for their future income, they are essentially doubling down on the tech sector to succeed. This is generally a mistake. You want to diversify, not concentrate. The same can be applied to us. Our livelihoods, pensions, healthcare, etc. depend on the economic growth of the U.S. That and it's been shown time and time again, that having a healthy international allocation improves risk-adjusted return. So hesitate just a moment before recommending doubling down on domestic.
TL;DR: Don’t be afraid of the F fund. It’s not going to zap your returns. Especially for those of you over 30. If someone has a high risk tolerance, they can consider capturing more of the small-cap premium instead of just going all stock. Most people only ever consider the C/S/I funds. That allows for 7 possible portfolios with varying percentages in each fund. If you keep in mind the F fund, you have 14 possible portfolio types. And don’t neglect the I fund.
If you all have different opinions or insights you'd like to bring up, I'd love to hear them I think this sub would greatly benefit from a discussion on portfolio allocation.