Tuesday, March 31, 2009

A Thrift Savings Plan (TSP) Investment Strategy For Today's Bear Market (Assuming You Want to Keep Skin in the Game.. Meaning Participate in Stocks)

If you have the urge to participate in the stock market, but want to minimize your risk, then consider reading the email below. It was sent to a friend of mine that I openly discuss the stock market with.

My email sent earlier today:

"Here's some guidance for you if you want to be a participant in the stock market.

(for Paul... The G-fund, referenced below, is the government 401k index that approximates the 30 year treasury).

This is my current guidance so long as the dow jones 200 day moving average is sloping downward. I intend to use the formula discussed below if the Dow jones drops below 6700 and there is no new significant "BAD" news in the market. This last stipulation is subjective. For the time being, I will keep my contributions restricted to the G-fund and will reallocate my TSP account twice per month after starting to use the below formula. I will cease using this model whenever the 200 day moving average on the dow jones industrial average slopes upward.

Additional details to understand about TSP:
- you are authorized to move funds between the G-Fund and other equity/bond funds up to two other times per month
- also, TSP account holders are able to do unlimited moves from equity funds to the G-fund (this is important if the stock indices rocket up like they did these past two weeks. If that occurs, you can start taking some profits off and move them to the G-fund if you like).
- naturally, your monthly contribution allocation will determine what percentage goes to each of the investment options.

The below formula is developed (a big SWAG by me) using the short term lows for the Dow Jones industrial average over the 1990s and plotting them against what I construe as reasonably safe percentage amounts to invest in equities. How did I determine what are "safe" percentages to invest in the stock market? I assumed that the lowest the dow jones could go is 4100. If it did, I would want any losses experienced by my position in equities to be completely offset by gains I make in the G-fund to give me a net return of approximately ZERO.. then fitting an exponential curve to the plot you get:

Net percentage invested in TSP equities = 12.667 * e ^ - 0.0007 * dow jones average

where e is the exponential function on your calculator roughly equal to 2.72

Using today's closing price for the dow you get:

Percent in TSP equities = 12.667 * 2.72 ^ -.0007 * 7522
Percent in TSP equities = 12.667 * 2.72 ^ - 5.2654
Percent in TSP equities = 6.52
Percent in TSP equities ~ 7%

If Dow hits 6500
y = 12.667 * 2.72 ^ -.0007 * 6500
y = 12.667 * 2.72 ^ -4.55
y = 13.35
Percent in TSP equities ~ 13%

If Dow hits 6000
y = 12.667 * 2.72 ^ -.0007 * 6000
y = 12.667 * 2.72 ^ -4.2
y = 18.94
Percent in TSP equities ~ 19%

If Dow hits 5600
y = 12.667 * 2.72 ^ -.0007 * 5600
y = 12.667 * 2.72 ^ -3.92
y = 25.07%
Percent in TSP equities ~ 25%

If Dow hits 5000
y = 12.667 * 2.72 ^ -.0007*5000
y = 12.667 * 2.72 ^ -3.5
y = 38.2%
Percent in TSP equities ~ 38%

If Dow hits 4600, percent in TSP equities ~ 51%

If Dow hits 4100, percent in TSP equities ~ 72%

I hope this puts things into perspective for you. Hopefully you'll find this useful in the event you want to participate in the stock market while minimizing potential losses.

Do you know how to get the 200 day moving average on the dow jones? If you click here you'll see a one year chart of the dow with the 200 day moving average highlighted in red.


Finance Junkie said...

The actual amount to have invested in the stock market when it bottoms could be closer to 100%. My formula comes up with a value near 72% if the dow hits 4100. The remaining 28% left invested in the G-fund is a buffer for added safety.

Finance Junkie said...

Added safety is important because nobody knows where the market bottom is. What I say in the article is my own SWAG to somewhat safely allow me to be a market participant.