Peaceful Gains Newsletters » Lifecycle

Small caps in the lead

Alex — Mon, 03 May 2010 00:40:43 +0000

We’re staying in the S Fund (“Extended Market”), since it appears to have the best prospects, though it is a bit overbought. Stock funds, such as the S Fund, C Fund (“S&P 500″), and L2040 (“Lifecycle 2040″), have high expected returns right now. On the other hand, though expected returns for the non-stock funds, like G Fund (“Money Market”), L2010 (“Lifecycle 2010″), and F Fund (“Total Bond”), are positive, they are on the low end of the scale. The I Fund (“Europe Pacific”) is a bit risky, but it might still bounce back. (follow: facebook, twitter, identi.ca, rss.)

Lifecycle fund equivalence

Each Lifecycle fund invests in a mixture of TSP Individual fund. The mix of Individual funds held by each Lifecycle fund changes with time. The only exception is Lifecycle Income — the mix of Individual funds that it holds is not supposed to change. As each fund’s target date approaches, the mix of funds that it holds is supposed to become more and more like the mix of funds that Lifecycle Income is holding.

Below is an estimate of the current holdings of each Lifecycle fund. Note that this is only an estimate and might not be completely accurate.

L2040: G 10 F 10 C 40 S 17 I 23
L2030: G 21 F 9 C 36 S 14 I 20
L2020: G 34 F 8 C 31 S 10 I 17
L2010: G 71 F 7 C 13 S 3 I 6
LIncome: G 74 F 6 C 12 S 3 I 5

“Your gains are among the best”

Alex — Mon, 14 Dec 2009 15:24:45 +0000

I was looking up information about the Lifecycle funds the TSP started offering in 2005, and your site came up on one of my searches. I’m looking at a wide variety of free help groups and newsletters to try and get a good picture of what are good strategies with the goal of either finding the best allocations from one source or a good synthesis strategy from the various sources available. Your gains seem to be among the best I’ve found.

-M.W.

Our investment method in more details

Alex — Wed, 21 Oct 2009 17:36:52 +0000

Question: I have been looking to get better returns from my TSP. However, I have trouble following any method without knowing how or why it should work (much like you state in your bio). I could not find any solid reasoning on your site. [Could you please describe your method.]

Response: There is a general framework for making investment decisions called “asset allocation”. This framework is popular with academics because, unlike technical analysis indicators, for example, it has a theoretical basis. However, the framework itself leaves out some details that you need in order to actually implement it. My method is an implementation of asset allocation, in which (I think that) I have worked out these details.

Here is how asset allocation works. Each investment has two characteristics, one called expected return, and the other called risk. Intuitively, here is how they are defined. If you took a large number of unrelated investments with the same expected return, then, on average, they would give you this expected return. Risk is a less clear concept. Usually, risk is taken to mean the standard deviation of logarithmic return, which is also called “volatility”. This is a good definition of risk because it is easy to understand — higher uncertainty in future returns means higher risk. However, the definition has some weaknesses. I have developed another definition of risk which I use in my algorithm.

Both expected return and risk are estimated from historical price data. In other words, mine is a “technical” system — it only uses historical price data. It does not use any “fundamental” information, such as earnings. The argument for technical analysis as opposed to fundamental is well known. Even if you think that fundamental information is relevant, by the time you, the investor, hear of it, a lot of other people have already heard of it and acted on it. Thus, any relevant fundamental information is reflected in the price before you even hear about it. By analyzing price, you can know all the relevant information. Plus, of course, technical systems are easier to test on historical data. Simulated performance is one of several pieces of evidence that your system works. See below for more on this.

(Just to clarify, even though asset allocation is a technical approach, it differs from most other technical analysis systems. Most technical analysis uses indicators, such as moving averages, or chart patterns, or other similar methods. However, there is no theoretical basis for those approaches.)

Since expected return and risk change with time, how to properly estimate them is a very big question. Many asset allocation methods, such as the one used by the Lifecycle funds within the TSP, actually assume that these investment characteristics do not change with time. I think that this is a major mistake.

Just as each investment has an expected return and risk, so does every combination of investments. Asset allocation says to pick the mix of investments that maximizes the expected return while not exceeding a fixed maximum risk. Of course, there is a huge number of investment combinations. Thus, it is not possible to check all of them using a “brute force” approach. However, with a good search algorithm, you can find a mix of investments with a high expected return that does not exceed your fixed maximum risk. That’s all there is to it. In my newsletters I give two allocations. The difference between them is that they have a different fixed maximum risk.

Lifecycle allocations, strategy, and performance

Alex — Mon, 21 Sep 2009 17:16:58 +0000

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%

Holding Lifecycle 2010, almost

Alex — Mon, 03 Aug 2009 04:27:05 +0000

We pick the mix of investments that maximizes the expected return while not exceeding a fixed maximum risk.

In this issue, I wanted to continue recommending the Lifecycle 2010 fund. However, for the benefit of our readers who are not TSP participants, we are instead recommending the equivalent mix of Individual funds.

Staying in L 2010

Alex — Sun, 19 Jul 2009 12:47:52 +0000

We are continuing to hold the Lifecycle 2010 fund in our Balanced allocation. In the Conservative allocation, we’ve shifted even more toward the G (“Money Market”) fund.

Shifting out of stocks

Alex — Mon, 06 Jul 2009 03:02:39 +0000

Stocks are getting shaky again, and so we are shifting out of them again. We are thus recommending the Lifecycle 2010 fund, as well as the non-stock G and F funds in our Conservative allocation.

Stocks growing stronger

Alex — Mon, 15 Jun 2009 04:31:35 +0000

We pick the mix of investments that maximizes the expected return while not exceeding a fixed maximum risk.

As stocks are growing stronger, we are moving more money into them in our Balanced allocation. The Lifecycle 2030 fund, which we are recommending, currently keeps about 71% of its money in stocks. However, since the risk of stocks has increased slightly as well, in the Conservative allocation, we are actually putting a little bit more money into the money market. We are doing this by shifting more money into the Lifecycle Income fund.