The Dow Jones Industrial Index closed above 12,000 for the first time this week. This is a new high for the stock index that is widely used to reflect the trends and current state of the stock market.
The S&P 500 index also moved up this week but it is not that close to a new high. The S&P 500 index is the one used by the C fund for the Thrift Savings Plan.
In practical terms, if you have money invested in the C fund, your investment is up about 11% so far in 2006. That is not a bad yearly return. If you have all of your money in the G fund, for example, you can expect a return of about 5% in the current interest rate environment and you have made about 4% on your money in the G fund so far this year. (Check out the historical annual returns for the TSP funds here.)
The ultimate goal for many investors is to be able to time the market. In other words, sell your stocks (or your TSP stock funds in this case) when the market is at a peak, put the money into the G fund to keep making money even when stocks are dropping, and then put the money back into stock funds when the market is at its low point. Do this, and you will make a financial killing.
With this goal in mind, should you now sell your C fund because the stock market is hitting new highs and put the money into the G fund? The stock market is seductive. It is good at setting investors up for a fall. It can make you giddy with the thought of your new wealth. It can also make you depressed as you contemplate how much money you would have made "if only" you had invested differently at the right moment.
If you think the market is going to drop far and fast, selling your C fund is a good idea. You will preserve your gains by keeping the financial windfall in the G fund until it is safe to invest in stocks again; that is, when the market has dropped and you can then make another windfall profit when it zooms up again.
Most of us try market timing in our own way. Many investors will say, at least in private conversations, they do not believe in market timing. But, when studying the bottom line of your TSP funds, it will be tempting to take the money and keep it safe. Conversely, when the market drops, many investors will react–eventually. Once the market has dropped enough so that it really hurts, they will give up and sell their stocks and put the money into a safer investment. In other words, they preserve their losses.
That has happened in the past few years and it will happen again. It always does. Here is what happened to TSP investors when the market bubble went bust several years ago.
Here are statistics compiled by the Wall Street Journal. In December 1999, TSP participants put $427 million into the C fund. (The C fund went up about 21% in 1999.) At the same time, they withdrew $427 million from their bond funds. In January 2000, another $728 million was moved into TSP stock funds. This was just about the peak of the bull market. Several months later, the bear market hit and hit hard. Stock prices started dropping. They continued to drop throughout much of 2000. (Check out the FedSmith.com stock tables to see a month by month return for any year.)
When TSP participants got their December 2000 statements, many realized for the first time what was happening to the value of their stock investments. TSP participants started selling their stock funds with abandon. From June through October 2002, when stocks were at their lowest levels, TSP particpants pulled $3.8 billion out of the C fund and put their money into bond funds.
This is market timing. It is also typical market timing as it loses the most money for investors. TSP investors sold their stock funds at the lowest levels just before the C fund jumped up 29% in 2003 (the I fund went up 38% and the S fund went up 43% in 2003).
And the bloodbath did not stop there. TSP participants kept putting more of their regular pay allocations into stocks throughout the bull market. The highest perecentage was 66% going into stocks in March of 2000 at the absolute peak of the stock market. As stock prices fell, TSP participants put less and less money into stocks on a regular basis with 47% going into stocks by the end of 2002.
TSP investors are not unique in this regard. It is just human nature.
It is also human nature to take advantage of this trait and to sell people on the notion that market timing can work and that if you will follow a simple formula (available to you for a small fee payable each week or each month), you can buy and sell your stock funds at the optimum time.
Unfortunately, the stock market is not very predictable. Stocks are currently high. That would seem to be a good time to sell and perhaps it is. On the other hand, it could zoom up another 10 or 20% or more in the next few months. If you sell now, you may be passing up a chance to retire several years earlier than you had planned.
Which scenario is the most likely? No one really knows. What is certain is that investors often pour money into stocks when they are at a high point and often sell at a low point. We get excited when our share prices go up. We get discouraged when they go down. We react emotionally and make a decision to buy or sell on our emotion of the moment.
So what should you do to avoid being caught in this financial trap?
Talk with a financial advisor. Have a plan for investing your money in the TSP and stick with it. This will vary for each investor and takes into account how long before you retire; you willingness to accept risk; and your ultimate financial goal. Once you know how much you should have in each fund, adjust the percentage of money in each fund periodically as necessary to reflect market changes. For many, this may mean putting your money into a lifecycle fund and leaving it there whether the market goes up or down. You will watch your TSP balance fall when it goes down but it will also go up–and in the long run it usually goes up more than it goes down.
If you do not have a plan for investing your TSP funds, you are likely to do what most people do–buy or sell based on today’s headlines. In the past, that has been a disaster for many investors. As a future retiree (or at least an investor who hopes to retire), you cannot afford to act based on the emotion of the moment.
For now, you can enjoy the moment. Your stock funds are up across the board. Just avoid acting on the emotion of the moment and remember you are investing for a purpose and for more than a day, a week or a month.