Timing TSP Investment Moves: Is it Possible? Chris Barfield 8/26/17 INTRODUCTION I feel like this massive thing deserves an introduction on what exactly it is. This started out as an examination of TSP allocation services that seem to be everywhere now. But to make the results be something more meaningful, I found it necessary to explain how markets work in general. This led to what amounts to a primer on investments, in addition to the analysis of the TSP allocation services. One of the more popular feedbacks I get on my newsletters is that I don’t go into enough detail. So I tried in this one. There are some parts where the math gets complicated, but there are also some very elementary investment principles included. Hopefully there is at least something for everyone in it. Here goes… Although it seems to have fallen out of popularity in recent years, I still remember clearly the days when many DUSMs, in between court assignments, were glued to computer screens, day-trading their stock portfolios. Winning stock picks were bragged about and shared routinely. Losers, not so much. For better or worse (and I’m guessing almost certainly worse), this day trading extended to the different funds of the Thrift Savings Plan. Most people had an opinion about when to move from the C to the S or I, and would execute their moves accordingly. Eventually all of this trading activity got the attention of the TSP board and in 2008 they changed the rules to restrict the number of interfund transfers a member could perform in one month. The current restriction is two interfund transfers per month, unless the second transfer is to a fund other than the G Fund. Then, the member is allowed additional transfers INTO the G Fund only. In other words, no one is ever trapped in a bond or equity fund, with no ability to get into the safe haven of Treasuries (I’ll explain each fund later for those that don’t understand these terms). Example One: On August 1st, Jim’s TSP is 50% C Fund and 50% S Fund. On August 17th, Jim transfers to 100% I Fund. On August 25th, Jim gets a little nervous due to some anxiety in the European markets and transfers 100% to the G Fund. Jim has completed he 2 allowable interfund transfers for the month and cannot make another transfer. Example Two: On August 1st, Meghan is 30% C, 30% S, and 40% I. On August 5th, a coworker talks her into transfering 100% to the F Fund. On August 15th, she decides she’s tired of trying to figure out how to allocate her balance among the funds, and wants to let the TSP allocate her balance for her, so she transfers everything into the L2040 Fund. She has completed her two transfers allowed for the month, but because she is not fully invested in the G Fund, she can do more transfers ONLY TO TRANSFER INTO THE G. So, Meghan talks to Jim and he convinces her that the markets are just too unstable now to be in equities. She decides to transfer 100% into the G Fund. This is permissible because the 3rd transfer is allowed if it is INTO the G Fund. (In Example One, the 2nd Timing TSP Moves Barfield Page 1 of 25 transfer went into the G Fund, so there would be no reason for a third, which is only allowed to transfer into the G.) Example Three: On August 1st, Mark distributes his TSP balance 30% into C, 30% into S and 40% into F. On August 10th, he transfers the 40% in the F to the C and the S, leaving him with 50% C and 50% S. On August 15th, he transfers half of the C to the G Fund. On August 20th, he transfers half of the S to the G Fund. Transactions 4 and 5 are permissible because they are moving money INTO the G Fund. In summary, you can always move money into the G Fund, even if you’ve made your 2 allowable transfers for the month. So, why did the TSP Board reduce the number of allowable transfers? Well, the first reason is one of cost. The TSP is one of the lowest cost retirement plans on the planet. And they seek to keep it that way. Additional transfers (trades) cost them money, time, and manpower, so they limited it. Secondly, there’s virtually no reason or benefit to frequent trading of an account like the TSP, the way it is set up. The funds are index funds (I’ll explain in a minute), so they are tracking huge combinations of stocks or bonds, making them less volatile than individual stocks or bonds. Also, there is a delay in the execution of your trades. If you request an interfund transfer during a business day before noon, it is generally processed at the closing price of that day. If you request it after noon, it is generally processed at the COB the following day. This makes it extremely difficult to capitalize on small, daily price movements, which is the goal of higher frequency traders. For example, if you were to place a market order for a particular stock, say Apple, in your private brokerage account, the transaction occurs almost instantaneously. If you place the order at 10 am, you could sell at 2 pm, and buy it back at 3:30 if you wanted, taking advantage of the various price swings in the stock price. The TSP doesn’t work that way. Your transfer becomes effective at the close of business either today or tomorrow. Unless one is sure of the closing price of an index fund on the following day, it is difficult to consistently day trade a fund like the TSP, so higher frequency interfund transfers become almost pointless. We will discuss market timing in depth a little bit later, but first, let’s talk about the various TSP Fund options. INDEX FUNDS 101 First let’s clarify some of our terms so we are all on the same page. Investors in general have several options for choosing where they want to put their money. For many years, you could buy single stocks or bonds. For example, if you had $10,000 to invest, you could buy $2,000 of GE stock, $2,000 of Coca-Cola bonds, and $6,000 of IBM stock. Each one of those purchases requires a separate transaction, and therefore a separate commission. And, even then, you are only in 3 different companies—hardly a strong diversification. In 1924, the first modern day mutual fund was created. A mutual fund seeks to solve some of the problems of buying individual stocks, particularly the high cost, and the lack of diversification. With a mutual fund, the investor doesn’t pick a particular stock—he simply picks the mutual fund he is interested in and sends them his check. Let’s assume he has the same $10,000 to invest, so he gives that money to Mutual Fund Company XYZ. They take his $10,000, put it with the money from thousands of other investors, and buy perhaps thousands of different companies’ stock. By doing this, the single investor now owns a tiny fraction of many companies, rather than just a few. This allows him to be diversified at a very low cost. The Timing TSP Moves Barfield Page 2 of 25 managers of these mutual funds sit around and spend considerable manpower trying to decide which stocks or bonds should be bought, and which should be sold in an effort to make the most money possible for the investors. This is why these funds are said to be actively managed—there are managers in the mutual fund company actively pursuing the best investments possible. They may buy and sell different investments monthly, weekly, or even daily. But, at their heart, remember this, because it’s very important: they are trying to beat the market. They want to invest in things that are going up more than the market. A group of very smart investors, who were also extremely accomplished at math, began to realize that it is very difficult to consistently beat the market. It is also very costly. Remember when I said that mutual funds may trade weekly or even daily? Every one of those trades requires commissions. These commissions are paid by the investors. In a mutual fund where the turnover of investments is very high, an investor may lose a significant portion of his return in fees and taxes that are a result of these numerous trades. This led to an idea to have lower cost mutual funds that accomplish the same diversification goal, but without all the fees. So, in 1974, the first index mutual fund was created. An index fund doesn’t try to beat the market; it buys the whole market. So, it’s performance is correlated to what the market does as a whole. Let me explain. We’ve all heard the phrase, “The stock market is up (or down) today”. What we are saying is that a particular index is up or down for that day. Indexes are separate from individual stocks. The “market” may crash on a day that Nike stock is up for example. The fact that the market is down, doesn’t necessarily mean that every single stock is down, only that the index as a whole is down. An index is simply a collection of a lot of investments.