Last week, we recommended stocks, though they were close to being overbought. Stocks did start going down abruptly mid-week, and we are no longer recommending them. Instead, we are recommending corporate bonds, which are in a low-risk up-trend.
Monthly Archive for September, 2009
Question: How can I find the distribution of the 2010. 2020, etc plans? Could investing partially in these plans result in a similar investment strategy and outcome?
Response: The distributions of the Lifecycle funds change gradually over time. It’s fairly straightforward to figure out what they are at any given point in time. But you have to remember that whatever distributions you find, they will change with time.
The investment strategy of the Lifecycle funds differs from my strategy. Even though the distributions of the Lifecycle funds change with time, these changes are pre-calculated a long time in advance. We don’t know exactly how long in advance, but I suspect it’s years.
This means that the Lifecycle funds do not respond to changing market conditions. When stocks become more risky, the Lifecycle funds do not respond by shifting money out of stocks. When stocks become less risky, they don’t respond by putting more money in.
The Lifecycle funds accomplish what I call “static diversification”. They are diversified in the sense that they are invested in several different markets. But this diversification is static because it does not respond to changes in those markets.
By contrast, my approach does respond to changing market conditions. When stocks are more risky, I put no or little money in them. When their risk declines, I put more money in them.
In my opinion, the performance of the Lifecycle funds is relatively poor. The funds with the longer time horizon, such as L2040, have most of the money in stocks. Thus, they have had performance similar to the performance of stocks, including the huge recent drop. The funds with the shorter time horizon, such as LIncome, have most of the money in the money market. While this is a lot safer, it also limits the potential return.
For example, since the beginning of 2007, assuming you have not made any contributions to your account, the returns are as follows:
- LIncome: +7.08%
- L2040: -10.90%
- C Fund: -19.66%
- G Fund: +10.98%
Question: In the two new newsletters, I note that the analysis of the direction of stocks is contradictory. In the ETF letter, stocks are said to be the thing for the next week while in the TSP newsletter, stocks are seen as risky over the next two weeks. Given that the only difference in the two letters is generally the number of changes that can be accomplished economically, would it not makes sense to wait one week before instituting the changes in the TSP allocation or am I missing something?
Response: I also saw that my algorithm was giving what looked like strange advice this week, so I investigated further. The reason for the differing recommendations is the time scale. Because the TSP newsletter is updated twice a month, while the ETF newsletter once a week, the TSP calculations use a longer time scale.
On the longer time scale used by the TSP newsletter, stocks look overbought. However, on the shorter time scale used by the ETF newsletter, stocks look close to being overbought, but not there yet.
About waiting a week with the TSP newsletter. I recalculate the optimal allocations for the TSP on the first and third Monday of the month. I have not found any benefit to attempting to time the market. That is why I simply recalculate the optimal allocations on a regular basis. There is nothing magical about first and third Monday — it’s just convenient and it splits the month into two approximately equal parts.
We pick the mix of investments that maximizes the expected return while not exceeding a fixed maximum risk. Stocks, bonds, and commodities have all been going up in the past couple of weeks. For the coming week, though, stocks look the most promising.
While we’ve made money in stocks in the past two weeks, the stock run-up could be weakening. For this reason, we are shifting some money out of stocks.
Question: Does the (3rd party) tracker you’re using “purchase” additional amounts each period? It looks like it just changes the existing/starting allocation, so that the comparison is like the usual “$10k invested at time x and then manipulated with our portfolio strategy would be worth $y today”. But that’s not really how your Newsletter works. It advises on how to invest each pay period’s existing assets plus the new investment coming in that period.
Ideally, the tracker would allow me to compare returns from Date x to Date y, and it would incorporate some investment amount per period z, starting with 0 at Date x (otherwise you can always rig the results with a bigger or smaller starting value at Date x). And it would allow comparisons to indices (such as the S&P 500) using the same mechanism. I suppose you could make the starting value a variable to be entered by the user, but leaving it unvariable and fixed at some amount determined by you (even if seemingly reasonable, like $10k) just opens you up to the criticism of manipulation.
Response: A lot of people think that each strategy has a particular return, but, as you point out, things are not that simple.
Even if two people follow the exact same strategy, their return might be different. This is because each person has some initial amount and some amount they are contributing throughout the investment period. We can think of there being two returns: a return on the initial amount (the lump sum return) and a return on the money contributed throughout (the dollar cost averaging return). The personal return is a linear combination of the two, with weights being proportional to the two sums of money (initial sum and the sum being contributed throughout). Since these sums differ between different people, so do returns, even if following the same strategy.
My methodology does not seek to simply maximize return — it seeks to maximize performance, of which return is an important part, but which has other components as well. Ideally, the goal is for the profit curve to go up more or less smoothly. This behavior achieves good returns, both lump sum and dollar cost averaging.
I haven’t seen a lot of discussion of this fact that each strategy has two returns. Whenever I see returns discussed, it is only the lump sum return that are being discussed. The ridiculous statement that “stocks go up in the long term” becomes even more ridiculous when we take dollar cost averaging into account. For example, stocks have lost money over the past 10 years, both on a lump sum and dollar cost averaging basis.
I think one reason why everyone just focuses on lump sum returns might be that this assigns just one easy number to each strategy. If you do things properly then strategy rankings would depend on each investor, which might be too confusing for some people.
Now, to answer your question. The third party tracker that I use reports only the lump sum return. I realize that that’s not how retirement savings works, but that’s what they report. I do not know of any service that accounts for DCA. If you do, please let me know. Also, you might want to email TimerTrac about this.
However, even though they only report the lump sum return, they also show you the full profit curve. They also allow you to see some “statistics” (if you click on “Graph with Statistics”). However, besides the maximum drawdown, I see those as being largely meaningless.
While stocks have been doing well in recent weeks, they could be overbought at this point. We are thus switching into high yield corporate bonds. They have been doing consistently well, and they do not appear to be in danger of being overbought.
Stocks in many different sectors are doing well. However, in our estimation, the best bets for the coming week are Chinese stocks and large-cap American stocks, represented by the Dow.
All of the stock funds are doing well, though their risk has gone up slightly in the last two weeks. We’re thus distributing our money among the stock funds, but leaving some in the money market and bond funds.
We’re putting most of the money into large-cap US and foreign stocks. This is consistent with this week’s recommendation in our ETF newsletter.