Asset allocation

This article discusses the method that we use to allocate money among the TSP funds. If you are not a TSP participant, you can still benefit from our newsletter if your retirement plan is similar enough to the TSP.

Like other asset allocation methods, our algorithm picks the asset mix that maximizes expected returns while not exceeding a fixed maximum risk. We use a proprietary risk measure developed by our founder, who is a Ph.D. statistician. We recalculate the optimal asset mix twice a month. This assures that our method responds quickly to market changes, while at the same time complying with TSP's interfund transfer rule.

Conceptually, asset allocation is simple.

  1. Pick a risk level that you are comfortable with.
  2. Consider all possible asset mixes whose risk is below this level.
  3. Calculate the expected return for each of these asset mixes.
  4. Pick the asset mix with the highest expected return.

The difficulty with doing asset allocation well is in the specifics. For instance, which risk level are you comfortable with? What is risk anyway? Mathematically, how do you measure it? And once you are done with figuring that out, how do you consider all possible asset mixes? For example, G Fund 32%, C Fund 64%, I Fund 4% is one asset mix; G Fund 11%, F Fund 3%, C Fund 63%, S Fund 7%, and I Fund 16% is another asset mix. As you can see, there is a huge number of possible asset mixes.

We believe that we have found a good method of implementing asset allocation that addresses all of these issues. Here are some features of our method.

  • We do not try to pick price lows and highs. We do not time the markets. We simply respond to changing market conditions.
  • We don't follow a static diversification rule like "70% stocks / 30% bonds". Our optimal asset mix is updated twice a month in response to changes in market conditions. Sometimes, we are diversified among several funds. Sometimes, we allocate all the money into a single fund.
  • We don't try to make predictions about the economy. Our belief is that if the economic factors that affect the market are really changing, that will be reflected in the market itself. We thus simply respond to changing market conditions.
  • We use our own proprietary risk measure, which we believe is better than other measures.

Also see

Long-term
annual return*
Peaceful Gains
Conservative8.97%
Balanced13.66%
Year-to-date**
Peaceful Gains
Conservative0.61%
Balanced-0.20%
TSP Individual
G Fund0.85%
F Fund0.49%
C Fund-1.88%
S Fund2.97%
I Fund-4.21%
TSP Lifecycle
L Income0.73%
L 20100.44%
L 2020-0.09%
L 2030-0.34%
L 2040-0.68%
Notes:

* Compound annual growth rate, 1995-2008.

** Ending May 1, 2009.

Starting October 15, 2008, returns for our allocations are verified by a third party. Returns prior to that are simulated.