I keep meaning to add a FAQ webpage to our site. I often respond to new member questions via email, but I am sure others have the same questions. Until I get to it, I thought a current member’s questions were very pertinent since my service and opinions tends to be different from other advisory services.
These answers also apply to Vanguard and other funds as well, but I answered it in terms of TSP funds the member asked about. For translation purposes, the C fund is the SP500 index fund. The S fund is the small cap fund that holds all the US companies not in the SP500 (VXF ETF). The F fund is a fixed income fund that tracks the Barclays US aggregate Bond fund (AGG ETF) and the G fund is a no-risk interest bearing fund.
Here are my short and concise answers to their questions – humor intended.
1) The “Current Model Allocation” tab of the website shows moves as of May 2017. Is this still current? I’m trying to get a sense of how often you send out updates.
Yes, our models are presently out of equities and will be looking to move back into equities in late October (at the earliest) per their objective formulas. The Advantage timing models are designed to only send two signals per year.
There is one Advantage model for each of the following funds: SP500 index (TSP C), non-SP500 small cap index (TSP S), the DJIA (DIA ETF), the Russell 2000 (IWM ETF), and the Total US Stock Market (VTI ETF). The Advantage models use the same strategy.
2) What is the difference between the Expedient Timing Model and Advantage Models?
The Expedient allows for more changes and provides an avenue for my subjective analysis. It is also important to note that the Expedient model is not the only way I subjectively inform member’s investment decisions.
I also provide market commentary for members on what I am seeing in terms of market risk and trends on our website without sending email alerts. I always send email alerts if I see indications of imminent large corrections. I use our Current Situation Report to try to capture the more strategic view of the market – to get out of the weeds and look at the forest and beyond.
We do not provide timing signals for market “trading” but our information should be helpful to include our unique TSP almanacs.
3) Is it up to the member to use Advantage W, C, S or R models based on their own risk tolerance? I’ve used other TSP advisory sites in the past such as “TSP Allocation Guide”, “The Fed Trader” and “TSP Investing” and they present their recommendations as simply being in C,S,I or G. Your recommendations use the Advantage Models and I’m trying to understand it better.
The Advantage models are not risk based in that sense. They were designed to provide optimized timing signals for each fund using the same strategy. You can pick your fund(s), but I also make recommendations on what equity fund to invest in via the Expedient model.
I define market risk as the risk of sustaining large losses due to corrections or bear markets. The TSP equity funds as well as our Advantage models have similar risk profiles from my prospective on market risk. In other words, diversification among the equity funds does not reduce your market risk since all the equity funds tend to correct or enter bear markets together.
So yes, the primary way to adjust your exposure to market risk is through your allocation percentages to equity funds versus the low-risk TSP F or G fund. More on how we do this below.
I do not see the S fund (small cap) as more risky than the C fund (large cap) just because small caps are more volatile. Some portfolio managers do equate volatility to risk, but in my opinion this is a red herring definition of risk for investors.
For example, if both the TSP C and S fund gain the same amount over a long period of time but the intervening moves of the S fund are much larger (more volatile) a portfolio manager might say the C fund is less risky even though they gained the same amount. The same goes for losses.
Often charts are presented with cherry-picked time frames that make the S fund look more like a high growth fund. Since the correction bottom in February 2016 TSP S fund outperformed but since 2011 the C fund has outperformed the S fund. Time frames matter. Since TSP set fund prices for all their funds at 10 in 2003, the TSP S fund has outperformed. If you take a look at our historical charts page, you will see the longer view.
If an advisory service adjusts risk by moving to the G fund then I agree, but if they are moving among the equity funds or only diversifying among the equity funds then I do not think they are avoiding the bulk of the risk.
so what does matter…
All of the major indexes are highly correlated in direction over time but with different amplitudes to up and down side. So diversification *among* the equity funds is not going to reduce your exposure to the (directional) market risk.
Again, the primary way to adjust your exposure to large losses is by reducing your allocation percentage to equity funds and increasing your allocation to the low-risk TSP F or G fund.
All the advantage models reduce market risk (risk of large corrections and bear market draw-downs) by exiting equities for the unfavorable half of the year and entering equities for the favorable half. In other words, we adjust exposure to equities twice a year based on the long established seasonal tendency of the markets.
The chart below breaks out the unfavorable half of the year for the TSP S fund (black plot). That means all the gains (and more) occur during the favorable half of the year. If you replace those unfavorable season losses with an interest earned in the TSP G fund you end up with the second chart.
Note: The blue plot on both charts is the TSP S fund buy & hold – a respectable 725% gain. By eliminating that 46% loss from the unfavorable season and replacing it with the TSP G fund interest, you bump your gain up to 2,382% gain. Not bad for only two trades per year.
And this is why I call it the Seasonally-Modified Buy & Hold strategy. We only Buy & Hold during the favorable season for equities when market corrections have historically been muted and gains have been most consistent. This is our primary risk mitigation strategy but not our only one.
More charts that highlight this discussion on our Results page.
About our seasonal timing signals…
When I researched the seasonal strategy, I found that each fund acted a little different even though they mostly move in the same direction over time. Originally, our timing signals for the funds were generated by each fund themselves.
I found that sending 4 different timing signals (one for each Advantage model) via multiple email alerts within days or weeks of each other was both cumbersome and confusing. During further research, I discovered a better timing signal generator that worked for all the funds – the Total US Stock Market fund.
It kinda makes sense if you think about it that the total market would be a good signal for the start and end of the favorable season for equities each year. I call this the Bellwether signal. This was not a change in our objective strategy, just the signal generator that we applied to all the models.
This change actually improved our Advantage results in back-testing. Since it reduced confusion too, it was a no-brainer to make the change. Since we still need to track the performance of the different funds we kept the separate Advantage Models. It might help in the future if I present them differently.
Bottom-line on risk…
I do not believe that you have to increase risk to increase your returns, exactly the opposite. Our Seasonally-Modified Buy & Hold strategy (reflected in all of our Advantage timing models) are all about mitigating risk.
I do not differentiate between conservative and aggressive investors… I think that all smart investors should reduce risk to increase returns on a seasonal basis. Those in or near retirement should further reduce risk by allocating less than 100% during the favorable season.
The argument that young investors have more time to make up losses so they should take on more risk is total bunk. No one should take on more risk than they have to.
I appreciate the questions from members especially new members who do not have all the benefit of my recent email alerts and reports to understand how our service works. I often take your questions and make updates to our webpages to be more clear.
I am currently working on our Fall Summary which will be accessible to all member levels well before our timing models signal re-entry. Hopefully, after the signals are in and email alerts are out, I can get to that FAQ page.
I spend much of my time researching other non-seasonal indicators that could be complimentary to our seasonal strategies. The goal always being to capture more of the market’s gains and avoid more of the market’s losses. But I do not take making changes lightly. We will see.
Currently much of my commentary and situation reports revolve around how unique this current market cycle is due to the global central banks basically taking control of financial asset prices via interest rate manipulation and quantitative easing.
This change in the investing environment is confounding a lot of traditional analysis and traditional strategies. Understanding the driver of the current market cycle is critical to informing our investment decisions going forward. We live in interesting times.
Thank you for your membership and questions!