By: Lyn Alden
The Thrift Savings Plan is elegant in its simplicity, offering investors five diversified low-cost funds and a lifecycle option to pull them together and rebalance them automatically.
However, all of the TSP funds consist of either stocks or bonds, with little or no exposure to other asset classes. This is fine, because stocks and bonds have historically been some of the best long-term asset classes to invest in, especially when combined. But many investors have IRAs or other investment accounts alongside their TSP and can use them to expand their total portfolio to include a variety of asset classes for additional diversification.
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The benefit of investing in several asset classes is that many of them may not be correlated, meaning that as one asset class declines in value another may rise in value. By diversifying broadly, you can improve your risk-adjusted returns and be resilient against multiple possible macroeconomic outcomes.
This was the philosophy that David Swensen, the investment manager of Yale’s endowment portfolio, used to substantially outperform all other institutional endowments over the past couple decades. He specifically took positions in other asset classes alongside his stocks, including low-liquidity investments, to maximize his portfolio’s potential.
Here is a list of investments that could complement a TSP well, because the TSP currently has little or no exposure to them:
The I Fund follows the MSCI EAFE index, meaning it is mostly concentrated in Japan and Europe and has zero emerging markets exposure. However, the Thrift Investment Board voted to change this sometime in 2019, so that the I Fund will follow a broader index that includes emerging markets as about 25% of its portfolio.
Until then, holding ETFs or other investments in emerging markets as a portion of a portfolio can make sense. The Vanguard FTSE Emerging Markets ETF (VWO) and the iShares Core MSCI Emerging Markets ETF (IEMG) are two low-cost examples.
The reason this is relevant is that most new growth in the world is coming from emerging markets:
It doesn’t hurt that emerging markets are trading at lower valuations, on average, than U.S. stocks.
Gold and silver are relatively uncorrelated with stocks. Often during a recession or global uncertainty, the price of gold rises while stocks fall. Silver has industrial uses and so its price tends to fall during a recession, but it historically recovers more quickly than equities and still serves as a good means of diversification.
There are several ways to get exposure for part of your portfolio. You can buy physical metals, you can invest in gold and silver ETFs (tickers: GLD and SLV, for example), you can open specialized gold savings accounts, or you can invest in individual gold mining companies or the gold mining company index (ticker: GDX).
Investment research by Fidelity has found that energy and materials stocks tend to outperform the broader stock market during the late phase of business cycles. Not every time, but usually.
Specifically, energy tends to outperform by about 12-14% and materials tend to outperform by 2-7%. And as far as consistency is concerned, they both historically outperform in this phase over 80% of the time:
The main reasons for this outperformance are that as the business cycle heats up at the end, inflation tends to kick in and consumption demand rises, both of which benefit producers of natural resources.
Energy and materials stocks have been beaten down in the last few years. Since the TSP equity funds are weighted by market capitalization, they invest less money into stocks after their prices decline. For that reason, the C Fund only has about 5.5% exposure to the energy sector and less than 3% exposure to the materials sector at the current time.
Investors that wish to have more exposure to these beaten-down sectors that historically do well during late-cycle business environments can invest in targeted ETFs, like the FlexShares Global Upstream Natural Resources ETF (ticker: GUNR) or the iShares MSCI Global Metals and Mining Producers ETF (ticker: PICK).
Lastly, real estate is historically one of the best-performing investments over long periods of time. Either owning your own home, owning individual rental properties, or holding Real Estate Investment Trusts (REITs) can give you exposure to this area.
Over the past 20 years, which included two recessions, REITs have been one of the best-performing asset classes:
A key benefit of real estate is that it holds up well in inflationary environments. If the asset itself increases in price due to inflation, while the debt used to finance it is fixed, the equity in the property can increase very rapidly.
The Vanguard Real Estate ETF (ticker: VNQ) provides easy access to REITs, and has been beaten down lately over concerns about rising interest rates, which value investors may find to be a good entry point:
For those that have knowledge and experience, investing in individual properties yourself can result in out-sized gains, because local real estate markets are less liquid and less efficient than the stock market and publicly-traded REITs.
Having a portfolio that includes real estate (even if just your house), diversified TSP equity and bond funds, and possibly one or more other asset classes, has been a long-term recipe for building wealth.