The Thrift Savings Plan (TSP) is the military’s retirement account. Learning how to maximize its utility should be high on your financial priority list. At MCCareer.org, I’m going to create a guide that will show you how to crush it with the TSP. We already showed you step 1 and step 2 in that guide. Here’s step 3…
The 3rd Step to Crush the TSP – Asset Allocation
You’ve probably heard that you shouldn’t put all of your eggs in one basket. That is what asset allocation is all about…making sure your eggs are in multiple baskets.
Asset allocation can be complex. There are entire books written about nothing but asset allocation, like The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk. That’s a good book if you want to nerd out, but I’m going to try and simplify asset allocation for you.
What Assets are Available in the TSP?
There are only five assets available:
- G Fund – US government bonds specially issued to the TSP
- F Fund – US government, corporate, and mortgage-backed bonds
- C Fund – stocks of large and medium-sized US companies
- S Fund – stocks of small to medium-sized US companies (not included in the C Fund)
- I Fund – international stocks of more than 20 developed countries
What is not available? There are a few major asset classes unavailable. You cannot invest in real estate or international bonds. International emerging markets may be added to the I Fund is the TSP board can ever sort out the politics. If you want exposure to any of these asset classes right now, you’ll have to get them in your other investment accounts, like your IRA or taxable account.
How Do I Pick My Asset Allocation?
If in step 2 you decided to use L Funds, you don’t need to pick an asset allocation for your TSP. The L Fund takes care of it for you.
If you are not going to use L Funds, one way to decide on an asset allocation is to take this Vanguard survey. At the top of the page it will give you a suggested allocation, such as 80% stocks and 20% bonds.
Another way is to borrow from trusted investment experts. Here are a few opinions.
In The Elements of Investing: Easy Lessons for Every Investor, Burton Malkiel recommends these age-based asset allocations:
- 20-30s – bonds 10-25%, stocks 75-90%
- 40-50s – bonds 25-35%, stocks 65-75%
- 60s – bonds 35-55%, stocks 45-65%
- 70s – bonds 50-65%, stocks 35-50%
- 80s+ – bonds 60-80%, stocks 20-40%
In the same book, Charlie Ellis recommends these asset allocations:
- 20-30s – bonds 0%, stocks 100%
- 40s – bonds 0-10%, stocks 90-100%
- 50s – bonds 15-25%, stocks 75-85%
- 60s – bonds 20-30%, stocks 70-80%
- 70s – bonds 40-60%, stocks 40-60%
- 80s+ – bonds 50-70%, stocks 30-50%
Mr. Ellis is a little more aggressive than Mr. Malkiel because he recommends a higher allocation of stocks.
There are other ways to come up with a reasonable asset allocation, such as financial “rules of thumb.” The founder of Vanguard, John Bogle, is famous for creating the “age in bonds” rule of thumb. It says that whatever your age is, that is the percentage of your investments that should be in bonds. The rest should be in stocks.
For example, I’m 44 years old, so his rule would say I should have 44% in bonds and 56% in stocks.
This rule has been criticized as being too conservative, so some have changed it to 110 or 120 minus your age as the percentage you should have in stocks. For example, for me this would mean:
- 110 minus age 44 = 66% in stocks, the rest (34%) in bonds
- 120 minus age 44 = 76% in stocks, the rest (24%) in bonds (this is actually very close to my asset allocation as of 9 AUG 2020, 75% stocks and 25% bonds)
There are certainly other ways to come up with your asset allocation. You could ask a financial advisor. You could read other books. You could read other blog posts, like this one on the Bogleheads Wiki.
What About Other Assets Like Your Pension and Social Security?
This is a tough issue. Some would argue that pensions and social security are income streams and that they should not play into your asset allocation decision. This is what Vanguard argues. Others would argue that they are “bond-like” and should be factored into your asset allocation and counted as a large pile of bonds. Here are a few thoughts on the subject from blogs I follow and trust:
- The Oblivious Investor – How Pensions and Social Security Affect Asset Allocation
- Humble Dollar – A Price on Your Head
The Bottom Line – Asset Allocation
Somehow you have to figure out your desired asset allocation. The info above will hopefully facilitate that. Once you have a target asset allocation, now you have to apply it to the investments available in the TSP. Take the 4th Step…invest.