“Hey! I love the podcast, and I’m hoping you might be able to tell me if my Lifecycle fund-based investment strategy overlooks any important factors. I still have close to 20 years until retirement, so I have a long time horizon. My strategy has been to invest my TSP entirely in the L-2055 Fund, even though the L-2040 is closest to my ideal retirement date. I hope to accomplish a few things this way; namely, to achieve a more aggressive portfolio allocation while retaining the automatic diversification and rebalancing that comes with Lifecycle funds. Otherwise, I would have no idea how to divide my portfolio among C, S, and I funds, and I would have to monitor the balances and periodically make interfund transfers to realign. I do the same thing with my outside IRA, and I figure it saves me the cost of paying someone to manage it. Is there some pitfall I haven’t accounted for? Thanks!” – Jacob
The Thrift Savings Plan (TSP) is one of our top three favorite benefits that Federal Employees receive for being employed with the Federal Government.
As Financial Advisors who specialize in working with Federal Employees, we are often asked what the best allocation strategy is for the TSP. We meet with hundreds of Feds from across the country each year and they want to know what investment choices that they should make within their TSP.
Jacob, a Federal Employee, asks us a great question about the Lifecycle funds. Jacob is mid-career with an expected retirement date of around 2040 so he has some time in front of him to participate in potential market growth in his retirement savings, his TSP. Like most Feds we visit with, Jacob also has an Individual Retirement Arrangement (IRA) that he personally holds. Should the management of both of the accounts mirror the TSP investments or should they be different for the sake of diversification?
Your investment allocations should really depend on your personal financial plan. No article written by someone that has not reviewed your personal financial situation should be a guide to how to invest in the markets – including this one! This article will not tell you how to invest your TSP because that is something that you should work through on an individual basis based on your financial plan.
What we will do though is walk you and Jacob through, from our point of view, some pros and cons of the various TSP Funds and what you should consider before investing. We will speak generically about really important investment strategies you should consider, from our perspective.
Our Hard Rule About Investing in the Stock Market
As financial professionals, there are seldom times that we use “hard rules”.” After all, there is so much volatility in people’s personal lives, the domestic markets, the international markets… and so on that creating a “hard rule” isn’t often realistic.
Except for this one. This is an investment rule that we work really hard to engrain in all of the Federal Employees that we work with to develop their financial plans, ready?
“Money that you need to use in the next 5-years should not be invested in the stock market.”
Why? Let’s look at a recent historical event called the Global Financial Crisis or as most people remember it, the year 2008.
In 2008 we saw the financial crisis begin to take hold and by March 06, 2009 the Dow Jones Industrial Average hit a market low of 6,469.95. The DJIA lost 54% of its market value compared to October 09, 2007.
In 2008 the TSP reported the worst earnings in its history. Remember when, during that period, the TSP experienced loses like,
- The international stock I fund losing 42.43%,
- The small company U.S. stock S fund down 38.32 %
- The large company stock C fund dropped 36.99%.
- The bond F fund gained 5.45%,
- The government securities G fund was up 3.75%.
- The 2008 returns for the lifecycle funds were: income, -5.09; 2010, -10.53; 2020, -22.77; 2030, -27.5; 2040, -31.53.
We cannot even count how many Federal Employees that we spoke with who had watched their TSP values be cut in half and made the emotional decision to transfer 100% of their remaining portfolios into the G Fund realizing their losses forever more.
Had those Federal Employees had a financial plan in place for WHEN (not IF) markets corrected, they may have been able to navigate that incredible tumultuous time in the financial markets a little better. Perhaps.
It is not IF markets will drop, it is WHEN.
In the financial world, markets pulling back and investments going down is not only a reality but it’s normal. This is why our hard rule is just that for us, a hard rule.
Money that you need to use in the next 5 years should not be invested in the stock market. Markets are too volatile and people are too emotional. You do not want to make a major financial decision in your portfolio when you feel the duress of uncertain economic conditions. Instead, you want a battle plan of how you will react when (not IF) they do.
Is the L-Income Fund Appropriate for Retirement Planning?
The L-Funds do a wonderful job of making financial allocation decisions “easy” for Federal Employees by deferring the responsibilities of reallocation as one draws nearer to retirement to a fund manager. Some Federal Employees really like this because, as they tell us, “they don’t have to think about it” and can allow someone else to ensure their investments are proportionally allocated in accordance with their anticipated retirement date.
The L-Funds ask the Federal Employee to choose a fund based on an anticipated retirement year that is most aligned with when the Federal Employee wants to retire.
Over the course of the years, the L-funds become less aggressive and more conservative as you draw nearer to retirement.
Here is what most Federal Employees forget about the L-Funds though and it is really important to understand because it will have a significant impact on your retirement planning.
The L-Funds anticipate that you will spend the majority of your TSP funds within 5 years of your expected retirement date. That is how their allocation strategy works.
The majority of the Federal Employees that we work with have the bulk of their retirement savings in their TSP. The TSP is a phenomenon accumulation tool but like any tool you have to know what it is designed to accomplish.
The TSP helps Federal Employees accumulate retirement savings. That is what it is designed for.
When you retire as a Federal employee, you’re 100% responsible for the longevity of your retirement. Make sure that you understand how the L-Funds work and ensure that this strategy is appropriate for your retirement plan.
Will you spend around 80% of your TSP retirement savings in the 5 years after retirement? Let’s look at an example.
Let’s say when you retire the balance of your TSP is $800,000. You’re invested in the L-Funds and you have 80% of your portfolio in the G-Fund (all theoretical here for illustrative purposes). That means you have $640,000 in the G-Fund not subject to any market losses (wonderful!) also not subject to any market gains (not so wonderful). In the next 5-years do you anticipate withdrawing from your TSP:
Year 1: $128,000
Year 2: $128,000
Year 3: $128,000
Year 4: $128,000
Year 5: $128,000
Oh and don’t forget… if invested in the Traditional TSP the monies are all pre-tax. That means when you make a withdrawal from your traditional TSP, you pay taxes on your withdrawal at your current tax rate.
Of course you will be retired so you may fall into believing the myth that when you retire your income taxes will be lower (not always the case for Feds).
TSP Bucket Strategy
To Jacob’s point, we think that he should look at an allocation that aligns to his long term financial goals.
Really sit down and think about our hard rule on investing and calculate how much money you will need to withdraw from your TSP in retirement to fill your retirement income gap.