What is your strategy for Thrift Savings Plan (TSP) allocations? If you have a TSP account, then you have a strategy – even if you’re doing nothing with it.
When considering a strategy to allocate your Thrift Savings Plan money, an understanding of each strategy and their benefits to you is essential. Each strategy involves risk (of losing money) and an expected return (how much money is made over time). In general the higher the risk tolerance, the better the potential money to make. There are six different strategies to use, explained below:
Strategic Asset Allocation – Also known as Buy and Hold, this strategy is executed by allocating a certain percentage to each fund and then leaving its allocation the same for long periods of time. The actual percentage to allocate is dependent upon how much risk is tolerated.
For example, a young person with many years to retirement may be willing to endure the risk (short-term loss) to gain the long-term high gains in choosing stock-heavy investment. While an older person, nearing retirement may wish to invest in the no risk G Fund, or lower risk F Fund, while getting less returns. A choice to invest for a long period in 50% C Fund (7% return expected) and 50% S Fund (8.5% expected return), gets an expected return of 7.75% (the combination of the two).
Constant-Weighting Asset Allocation – This approach uses the buy and hold, or Strategic Asset Allocation above, with a rebalance of the percentage in each account periodically. The assures that the original strategy is adhered to even as one fund may gain more than another and hence increase the fund balance. This is considered less risky to achieving the investor’s goal, than leaving the balance unadjusted.
For example, an investor has allocated 40% C Fund, 30% S Fund, and 30% F Fund. And over the course of a year the C Fund has gained 5%, the S Fund has gained 1%, and the F Fund has lost 2%, so that the allocation now stands at 41.3% C Fund, 29.8% S Fund, and 28.9% F Fund. The strategy calls for an interfund transfer with the original percentages of 40%, 30%, and 30%.
Tactical Asset Allocation – When there are short term opportunities to gain bigger returns, moving money between funds to take advantage is using Tactical Asset Allocation. However once the short-term opportunity is finished, a move back the a Strategic Asset Allocation is done. The realization of these short-term opportunities are difficult to time right, and have some risk of being incorrect.
For example, an investor has recognized that the stock market keeps losing money and decides to avoid losses by moving money from the C Fund to the F Fund for 3 months. And at the end of 3 months moves the money back to the C Fund.
Dynamic Asset Allocation – The constant changing of allocations based upon market conditions to achieve greater returns is Dynamic Asset Allocation. Ideally money is moved out of a declining fund, and moved into a more profitable fund. This is anticipating the future returns to be based upon historical information, or upon information that indicates what the performance will be. This can be a risky approach if there isn’t good information – but with good information, this will have better returns than other strategies. All three of the TSPinvestor strategies (Basic, Plus, Apex) use this.
For example, using the TSPinvestor Apex an investor changes allocations every month as scheduled, and at the recommended percentage. The allocation percentages move money to avoid short-term losses and take advantage of short-term gains.
Insured Asset Allocation – This strategy is used to insure a minimum return, while trying to gain more by using other strategies when the minimum is met. It is typically invested in risk-free (such as the G Fund).
For example, an investor decides that he/she wants a minimum of 1% return guaranteed per year. The risk-free G Fund is expected to gain 3% for the year. And so some risky stock investing (C Fund) is made, and if there are losses, the money is moved back into the G Fund to guarantee the minimum return. If there are gains a strategy to reserve some of the funds for the guarantee return is made and remaining is continued in the stocks.
Integrated Asset Allocation – This strategy is combination of any of the above strategies in a mix that suits the investor. Its advantage is giving the investor the opportunity to manage risk to suit his/her tolerance.