What Is The Thrift Savings Plan?
The Thrift Savings plan, better known as “TSP” is a retirement savings plan similar to 401K plans that is offered to federal employees and members in the military. The purpose of the TSP is to give these individuals the ability to participate in a long-term retirement savings and investment plan. Similar to the private sectors 401k plan, saving for your retirement utilizing the Thrift Savings Plan provides numerous advantages including:
- Automatic payroll deductions
- A number of investment options including managed lifecycle funds
- Choice of a traditional (pre-tax) TSP or Roth TSP (Post-tax)
- Low administrative and management expenses
Investing In The TSP
The TSP offers you two approaches to investing your money:
The L Funds — Better known as the Lifecycle funds are invested according to a professionally designed allocation of stocks, bonds, and Government securities. You select your L Fund based on the date you plan to retire and start withdrawing your money. For Example: If you are set to hit the retirement age in the year 2039 you would invest in the L 2040 fund.
Individual Funds — These distinct funds allow you to make your own decisions regarding your investment allocation and risk tolerance. You can allocate your contributions to any of the following individual funds at your discretion:
The Government Securities Investment (G) Fund — The G Fund is invested in short-term U.S. Treasury securities. It gives you the opportunity to earn rates of interest similar to those of long-term Government securities with no risk of loss of principal. Payment of principal and interest is guaranteed by the U.S. Government. Basically, the money you contribute to this fund is secured by the U.S. Government and therefore should not result in a loss of your capital. However, you will only acquire interest on this account, no capital gains or dividends.
The Fixed Income Index Investment (F) Fund — The F Fund is invested in a bond index fund that tracks the Barclays Capital U.S. Aggregate Bond Index. This is a broad index representing the U.S. Government, mortgage-backed, corporate, and foreign government sectors of the U.S. bond market. In summary, the bond market is typically stable and offers a higher rate of return than the G fund.
The Common Stock Index Investment (C) Fund — The C Fund is invested in a stock index fund that tracks the Standard & Poor’s 500 (S&P 500) Stock Index. This is a market index made up of the stocks of 500 large to medium-sized U.S. companies. In short, this fund is supposed to mimic the S&P 500.
The Small Capitalization Stock Index (S) Fund — The S Fund is invested in a stock index fund that tracks the Dow Jones U.S. Completion Total Stock Market (TSM) Index. This is a market index of small and medium-sized U.S. companies that are not included in the S&P 500 index. Bottom line, this is considered the growth fund, which means in theory you should expect higher returns but more volatility as well.
International Stock Index Investment (I) Fund — The I Fund is invested in a stock index fund that tracks the Morgan Stanley Capital International EAFE (Europe, Australasia, Far East) Index. This is a broad international market index, made up of primarily large companies in 22 developed countries. Let’s keep it simple, this is the high risk / high reward fund. During bullish periods this fund typically soars and during bearish periods it crashes hard.
How To Invest In The TSP Successfully
In order to invest your retirement successfully you should only pay attention to 2 of the individual funds (I will tell you why in a minute).
- The G Fund, which acts as a money market account earning less than 1% return annually but preserves the capital that you contributed.
- The C Fund, which is aimed at mimicking the return of the S&P 500.
1. How To Manage Contributions
The government matches up to 5% of government employees annual salaries. Therefore, I would recommend you only contribute up to 5%, any contributions over 5% will not be matched. For example, if 5% of your salary is $3000/year then the government contributes $3000/year to your account for a combined total of $6,000/year. A 100% return on your money instantly! You can’t beat it and if you are not doing this you’d better have a good reason! **NOTE** As of this writing the government does not match TSP Contributions for military service members.
When contributing money to your TSP you need to monitor 2 indicators to base your decision:
- S&P 500 Monthly Exponential Moving Average (EMA)
- Shiller PE10 Ratio
2. How To use the S&P 500 Monthly EMA:
Let me be crystal clear, there is nothing magical about the EMA. It is used to simply establish and follow a trend. The system is simple, so simple in fact a 3rd grader can understand and implement it. This is no scam or gimmick and I will prove it to you in a moment. At the end of every month, check the price of the S&P 500. If the price is ABOVE the established EMA, then leave your money vested in the C Fund. If the price of the S&P 500 is BELOW the established EMA, cash out of the C Fund and move your capital into the G Fund.
Take a look at how this strategy has worked over the past 20 years!
As I said it is so simple a 3rd grader can understand it. Here is a general summary of how you would have performed:
- 1993 – 2001: 225% Return
- Mid 2003 – 2008: 40% Return
- Late 2009 – Present: 42% Return (Not accounting for the whipsaws that occurred)
Please keep in mind that these returns DID NOT include dividends issued, which is a huge factor when calculating long term gains. The main take away for you is to FOLLOW THE TREND!!
3. How I use the Shiller PE10 Ratio
The S&P 500 consists of the “top” 500 publicly traded companies in the United States as determined by Standard & Poor. With that being said by purchasing shares in the S&P 500 you are purchasing 500 different companies. For long term investors it is wise to ONLY allocate NEW money when the the S&P 500 is trading at fair value or a discount.
What is a fair value for the S&P 500? I use the Shiller PE10 ratio to determine this, a Shiller PE Ratio of 15 is fair value!
- If the Shiller PE Ratio is under 15 then you should allocate contributions from your paycheck into the C Fund.
- If the Shiller PE Ratio is over 15 then you should allocate contributions from your paycheck into the G Fund.
It’s that simple!
Let’s take a look at how this system would have done over the past 20 years.
Unfortunately there was only one buying opportunity within the last 20 years when the S&P 500 was trading under fair value. This is typical, rarely do good businesses trade at a discount to value.
4. How To Put It All Together
But wait a minute… you just said put your money in the C Fund when the S&P 500 trades above the established EMA but then turn around and say you only allocate new money to the SP 500 index fund when the S&P 500 is trading under fair value. I’M CONFUSED!!!
I apologize for the confusion, but I had to explain both steps separately in order for you to understand their purpose. Now that we have both concepts down I am going to give you the rules one by one.
- Rule #1: If the Shiller PE Ratio is below 15 I allocate ALL capital into the C Fund.
- Rule #2: Rule #1 trumps everything else!
- Rule #3: Utilize the S&P 500 established EMA method when the Shiller PE Ratio is ABOVE 15.
Whew! There you have it. This is how to invest in the TSP successfully.
I know this requires an active approach in your TSP and far exceeds making a one time decision when you first join the government or military then forgetting about it. I will tell you however that it is WELL WORTH the 10 minutes a month. If you still need further convincing take a look at how this system actually maximizes your investment in the Thrift Savings Plan.
If you want to make it easy on yourself, you can sign up to my monthly newsletter where I monitor these indicators and give you the results.
Here’s to our Wealth!