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# TSP Model Performance Metrics

The performance of an investment strategy can be measured using a series of basic financial metrics. These industry-standard metrics allow investors to assess both the quality of returns, as well as the amount of risk, that a particular strategy has delivered.

We’ve summarized these performance metrics for our TSP Allocation Model in the table below. However, unless you happen to be a particularly savvy investor, there’s a good chance you have no idea what all these numbers mean. Not to worry, in this section we’ll break down each of these metrics so that you can get a better understanding of the TSP Model’s true capabilities.

TSP Model Performance Metrics
Strategy Compound Annual Return Alpha1 Beta1 Standard Deviation Maximum Drawdown Sharpe Ratio Sortino Ratio Treynor Ratio
TSP Model 9.56% 5.51% 0.46 10.87% -12.68% 0.81 3.61 0.19
G Fund 3.20% N/A 0.02 1.21% N/A 1.62 44.58 1.27
F Fund 4.42% N/A -0.01 2.98% -3.76% 1.08 5.23 -2.24
C Fund 6.87% 0.00% 1.00 17.61% -50.92% 0.41 0.53 0.07
S Fund 8.69% 1.38% 1.13 20.92% -52.22% 0.46 0.69 0.08
I Fund 5.29% -1.17% 1.02 20.57% -57.16% 0.30 0.40 0.06
Data for 17-Year Period (2002 – 2018)           1 Benchmarked against the C Fund

#### Compound Annual Return

The compound annual return is the rate of return that an investment strategy has achieved over time. It represents the cumulative effect of a series of gains and losses on an original amount of capital. In the chart below, you can see that the TSP Model has delivered a higher compound annual return than any of the individual TSP Funds.

The second best performing fund was the S Fund, and while you might be tempted to think that investing in the S Fund is comparable to the TSP Allocation Model, that would be a flawed assumption. That’s because in addition to looking at overall returns, we must examine how much risk an investor had to take to earn those returns.

There are three primary metrics that are used to quantify risk: standard deviation, maximum drawdown, and beta. We’ll examine each one of these now.

#### Standard Deviation

Standard deviation is the most common measure of risk used in the financial industry. It measures the variability of returns over time. The lower the standard deviation, the more consistent the returns are, and therefore the more “safe” a particular strategy is. A higher standard deviation, on the other hand, implies that returns fluctuate wildly from one year to the next.

In the chart above, you can see that the TSP Allocation Model has experienced much lower volatility than any of the stock funds (C, S, and I Funds). It does have more risk than both the F Fund and G Funds, but that is to be expected, as those funds only invest in fixed income securities.

Notice that the S Fund has the highest standard deviation of all the TSP Funds. This means that the S Fund carries the most risk. In the next section, we’ll see how this additional risk translates into big losses.

#### Maximum Drawdown

Maximum drawdown is one of the more intuitive ways to measure risk. It looks at the biggest peak-to-trough decline that an investment strategy has ever experienced. It should come as no surprise that the smaller the maximum drawdown, the better. We can see maximum drawdowns for each of the TSP Funds, as well as the TSP Allocation Model, in the chart below.

Notice that each of the stock funds (C, S, and I Funds) have fallen by more than 50%. If that comes as a bit of a shock, then you’re probably not going to like hearing that drawdowns of this magnitude have actually occurred twice recently, during the financial crisis and also during the dot-com collapse.

Our TSP Allocation Model, on the other hand, has experienced a maximum drawdown of only 12.7%. That means if you had been following the TSP Model, your account would never have fallen by more than 12.7% during any of the treacherous periods we’ve been through.

This chart is one of the most clear in terms of demonstrating the merits of the TSP Model. By now you should be able to recognize that the TSP Model allows you to participate in more upside than a 100% stock portfolio can deliver, but also be exposed to significantly less downside risk.

#### Beta

Beta measures the volatility (risk) of an investment strategy relative to holding a basket of stocks known as the S&P 500. A beta of 1 implies the same level of volatility as the S&P 500, while a beta less than 1 implies less risk, and a beta greater than 1 implies more risk. Once again, we can see in the chart below that market risk for the TSP Model is significantly lower (less than half) what it is for the other stock funds (C, S, and I Funds).

Based on these betas, we can again conclude that the S Fund is the most risky, as it experiences even more volatility than the S&P 500. The C Fund, which is actually an index fund that tracks the S&P 500, has a beta of 1, as does the I Fund (1.02).

By this point you may have noticed that both the F and G Funds have much lower overall levels of risk than any of the stock funds, or the TSP Model. This is to be expected, because once again, these are fixed income funds and they deliver substantially lower returns over time.

Now that we’ve covered the metrics that identify both risk (standard deviation, maximum drawdown and beta) as well as returns (compound annual return), we can combine these measures to get a better understanding of risk-adjusted returns. This is considered the holy grail of investing because it represents how efficiently capital is deployed … Anyone can increase returns by taking on more risk, but great investment strategies deliver high returns while taking less risk.

#### Sharpe Ratio

The Sharpe ratio is the industry standard method for measuring risk-adjusted returns. It looks at the excess return earned in relation to the standard deviation (or volatility) of those returns. With Sharpe ratios, a higher number reflects greater risk-adjusted returns (a good thing).

In this chart we can see that the TSP Model is able to deliver substantially higher risk-adjusted returns than any of the stock funds (C, S, and I Funds). The G and F Funds are able to obtain higher Shape ratios, but again, the trade-off here is substantially lower total returns (less than half for the F Fund and less than a third for the G Fund).

When it comes to deciding how to invest, Shape ratios are an extremely important consideration because they demonstrate the true effectiveness of an investment strategy. Just make sure to view the Sharpe ratio in the context of the actual returns provided.

For example, while the G Fund has the highest Sharpe ratio, it has only provided a 3.20% compound annual return over the past 16 years, which frankly, is terrible. The G Fund is able to deliver this high Sharpe ratio because it is immune from ever taking a loss.

#### Sortino Ratio

The Sortino ratio is another measure of risk-adjusted returns that is very similar to the Sharpe ratio. However, instead of comparing returns against the total volatility of a portfolio, it compares returns against only the downside volatility (or risk). The assumption here is that volatility to the upside (higher than expected returns) is a good thing, and therefore shouldn’t be penalized.

As with the Sharpe ratio, higher values here represent more effective use of capital.

Let’s quickly address the elephant in the room, or rather, chart. The reason the G Fund has such a high Sortino ratio is because the Sortino ratio takes into account only downside risk, and the G Fund doesn’t have any downside risk because it’s guaranteed to never experience a loss. So while it tends to distort the chart, for our purposes you can once again ignore the G Fund (unless 3% returns excite you of course!).

Comparing the TSP Model against the other stock funds with which it competes, you can again see that it delivers vastly higher risk-adjusted returns. This is to be expected, since the TSP Model is much better at limiting losses than the C, S, and I Funds (recall the data we looked at regarding maximum drawdown).

#### Treynor Ratio

The last measure of risk-adjusted returns that we’ll look at is called the Treynor ratio, and like the previous two metrics we examined, higher values are better. In this case, the measure of risk used is beta. So we’re looking at the excess returns achieved with regard to overall volatility in relation to the S&P 500.

As you can see, the message here is the same. The TSP Model has significantly outperformed the C, S and I Funds in terms of risk-adjusted returns.

At this point you probably understand why the G Fund again shows the highest risk-adjusted returns, but you might be wondering why the F Fund has a negative value. This is simply because the F Fund has a negative beta, meaning it is inversely correlated with the S&P 500. That negative value flips the entire ratio upside down.

#### Alpha

At this point the only metric we haven’t discussed is Alpha. Alpha is defined as the excess return earned above a specific benchmark (in this case, the S&P 500).

What alpha attempts to do is answer the question: If an investment strategy experiences the same volatility (risk) as the S&P 500, how much additional return would have been earned above what the S&P 500 delivered? In other words, did the investment strategy add value to what would have otherwise been achieved by simply investing in an S&P 500 index fund?

Due to the nature alpha, it does not make sense to calculate a value for fixed income funds such as the F or G Funds. In addition, since the C Fund is itself an S&P 500 index fund, it will have an alpha of zero. We can see the alpha values for the TSP Model, as well as the S and I Funds below.

What this chart shows is actually quite eye-opening if you understand the data. It tells us that if the TSP Model had experienced the same amount of risk as the S&P 500 (or C Fund), it would have earned an extra 5.51% per year above what the S&P 500 delivered. That’s an awful lot of outperformance.

In comparison, if the S fund were de-risked to have the same amount of volatility as the S&P 500 or C Fund (we know from the risk metrics outlined above that it has more), then it would have outperformed the S&P 500 by 1.38% per year. In contrast, the I Fund did have roughly the same amount of risk as the S&P 500, and it underperformed that index by 1.17% per year.

#### Conclusion

When it comes to understanding the effectiveness of an investment strategy, the metrics we’ve outlined here are critical because they offer a complete picture of overall performance. Rather than focusing only on returns, as most investment managers do, we’ve lifted up our proverbial skirt to show you the risk that is inherent in our strategy as well. As a secondary benefit, this performance data also provides you with everything you would need to compare our TSP Model against other strategies in an apples to apples manner.

By taking the time to dig deeper into the TSP Model’s historical performance, we hope you’ve come away with a greater sense of why we believe it is the absolute best way to manage your TSP Account. There are competitors in this space, but none of them offer the consistent performance and low-risk characteristics of the TSP Model.

Find Out How to Use the TSP Model to Manage Your TSP Account