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How Should You Diversify Your TSP Portfolio?

By Ralph Smith

Wednesday, October 6, 2004

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One question we get asked quite often (and consistently refuse to answer), ususally goes something like this: "Your articles often talk about the necessity to diversify investments between stocks and bonds. How much of my TSP retirement investments should I put into stocks and how much into bonds?"

We don't provide a definitive answer to this for a couple of reasons. One big reason is that each person is different with different expectations, different risk tolerance and different time until planning to retire.

Since we have not been willing to provide individual financial advice, one reader asked us to provide a general guideline on how to invest TSP funds.

FedSmith.com is not a financial advisor. But we do provide a news service. Shortly after seeing this reader's question, the investment firm of T. Rowe Price came out with a short article in their investment magazine with this title: "How do I determine my portfolio allocation?"

So, with that in mind, here is what the Vice President of Financial Planning for T. Rowe Price has to say about this issue.

As a general rule, to determine your portfolio allocation, you can use this formula. The percentage of your investments to invest in stocks is 110 minus your age, multiplied by 1.25.

The example used to illustrate the rule of thumb is this: if you are a 40 year old investor, subtract your age from 110 (110-40=70); 70 x 1.25 = 87.5. In other words, this investor would have 87.5% of his investments in stocks using this formula and 12.5% of investments in bonds.

TSP investors should keep in mind that the 87.5% of investments in stocks would not all go into the C fund. Instead, to diversify your investments and spread your risk, your money should be spread between the C fund, S fund and I funds. You can check out the recent TSP results to see a clear example of why diversification is a good idea--the smaller S and I funds have outperformed the larger, more traditional C fund which is based on the stocks in an overall index of stocks.

One other piece of advice from T. Rowe Price: Don't forget to periodically rebalance your portfolio. In other words, if your stock investments have a very good year and you find your stocks taking up 95% of your portfolio, you should rebalance to put more of your money into the bond funds.

So, there you have it. That is one piece of advice for investors on how to spread the risk in your portfolio from one of the nation's leading mutual fund companies.

Will this formula work for you? Don't ask because we won't tell.

© 2008 FedSmith Inc. All rights reserved. This article may not be reproduced without express written consent of FedSmith Inc.

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