Ask The Experts: Money Matters

By Mike Miles

Don’t let rational fear lead to irrational action

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If you have any of your Thrift Savings Plan account invested in the C, S or I Funds, you should be nervous. Why? Not because of the Ebola virus, turmoil in the Middle East, the national debt or legislative gridlock. Sure, those are all significant threats to various interests in various ways, but, whether you realize it or not, the threat those pose to stock values are already reflected in the share prices of the various TSP funds. Professional investment managers are not paid to wait for bad things to happen before responding. They are paid to predict the probabilities of future events and respond to opportunities and threats in advance — which they do.

The reason to be nervous about stock prices, here, is simple: Stock prices are near their all-time highs and have advanced ahead of expectation for the better part of five years. As prices rise, the risk of loss increases. Declines in stock prices are inevitable. Unfortunately, the timing and magnitude of those losses is impossible to reliably predict.

The fact that you’re invested in any of the TSP’s three stock funds should indicate that you expect to need the returns they can produce to meet your lifetime financial goals. If you can achieve your goals with less risk, then why wouldn’t you take the safer route? But needing the greater return means that the “right” portfolio will include exposure to stocks and the risk of loss they bring. If this is the case, then any portfolio allocation that does not include stocks is “wrong” for you.

Going back to the basic nature of stock losses; their inevitability and unpredictability mean that if you’re in the right portfolio, and that portfolio includes stocks, you will suffer losses from time to time. As an investment manager, you must accept this fact. Unfortunately, many do not and they futilely attempt to avoid losses by abandoning the right allocation in favor of a wrong one. This is an example of a rational fear leading to an irrational action: Exchanging the right portfolio allocation for a wrong one. The move is irrational, because it is made in an attempt to avoid the unavoidable.

Let’s look at this from a logical perspective. If you’re in the wrong portfolio, your financial plan will fail. If you’re in the right portfolio and it includes stocks, you will lose money from time to time. But, does losing money equal failure? This depends upon how you define failure. If your only objective is to avoid losses, then losing money equals failure. But, if you define failure as failing to meet your lifetime spending and wealth objectives, then the two are not necessarily synonymous. If your financial plan relies on never losing money to succeed, and you must also invest in stocks to succeed, then you have a serious problem. You can’t invest in stocks and reliably avoid losses, the two are mutually exclusive.

The solution to this problem is to first minimize the risk of loss by limiting your exposure to risky assets to only that which is necessary to support your lifetime financial goals. Then minimize the risk posed by these assets by properly diversifying them, and develop and manage a spending plan that will tolerate the inevitable losses without failing. Maintain the properly diversified portfolio asset allocation at all times.

This means never moving to the “wrong” allocation to avoid losses, which is an inherently irrational tactic. Consider the risks that you take on when you make such a move. Without a solid plan for subsequent action, moving to the wrong allocation isn’t part of a strategy at all. It’s like jumping out of an airplane without a parachute in response to a sudden loss of altitude. The questions you’ll have to answer after you jump out are probably tougher than the ones you’d have faced if you stayed aboard. Fear in this situation is reasonable. It’s what you do in response that deserves careful consideration.

Mike Miles is a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Ashburn, Virginia. Email your financial questions to fedexperts@federaltimes.com and view his blog at blogs.federaltimes.com/federal-money.

TSP contributions

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Q. I will retire Jan. 2 in CSRS. I believe the paydays on Jan. 2 and Jan. 16 will be part of the 2015 TSP contribution year. Also, I believe that I can contribute up to 100 percent of my basic pay to TSP (which is what I would like to do for these last two pays). Would the 100 percent be whatever is left after all other deductions (taxes, FEHB, etc.) have already been deducted? Essentially, when does the 100 percent get applied?

A. The 100 percent is applied after all required deductions have been subtracted.

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TSP transfer

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Q. I have been retired from the federal government for eight years and have worked for a private firm. I have a 401k that I have been contributing to since I started working for this firm. Can I transfer my existing 401k to the TSP when I stop working.

A. Yes, as long as it doesn’t contain any after-tax money. Use Form TSP-60.

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Annuity eligibility

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Q. I was just hired by the VA (NTE only lasting 2 months, Excepted) at age 58. How long must I work before I am eligible for a monthly pension? How long must I work before I am eligible to keep retirement thrift plan? How long must I stay before I am eligible for retirement medical benefits?  I am assuming that I will find a permanent job but does this NTE time count toward something? Read the rest of this entry »

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Why market timing is a sucker’s bet

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I have written about the perils of trying to time the investment markets for years, but I continue to receive questions from readers who use it to manage their Thrift Savings Plan accounts. There are a number of ways to effectively attack this misguided strategy, and the trick is to find the one that resonates with each investor. This time around, I’ll discuss the risk that market timers either don’t see, or choose to ignore: long-term risk.

Market-timing strategies are focused in avoiding near-term risk:; the risk of losing money to market declines, or the risk of failing to capture strongest returns when markets rise. Let’s refine our definitions for better clarity. Avoiding the risk of loss through market timing means being out of a market when you should be in it, while avoiding the risk of missing gains means being in the market when you should be out of it. This makes sense if you compare each of these exceptional states to the base, neutral state of being in the market when you need to be to achieve all of your investment objectives. This state is achieved by keeping your account invested in the mix of funds that is reasonably expected to support your lifetime financial goals with the minimum of risk. Timing decisions produce deviations from this base state, which I’ll call “properly invested.”

Of the two timed investment states you can be in, — over-invested or under-invested, — compared to the state of being properly invested, being over-invested is the easiest to discredit. In this case, you’re exposing your assets to the risk of loss to try to capture gains that you’ve already determined you don’t need to support your goals. Why would any rational person risk losing money they’ll need in order to chase gains they won’t? They wouldn’t, and neither should you.

The state of being under-invested is a little trickier to understand. The lure of avoiding the risk of loss is strong, and I regularly encounter TSP investors who want to retreat to the G Fund to avoid the risk of losing money in the C, S or I Funds. An otherwise intelligent TSP participant recently recited a common refrain: “The stock market is over-valued, and I’ll wait for a better opportunity to get back into stocks.” The basic instinct to avoid risk is beneficial, but a certain amount of risk is probably necessary to achieve your long-term objectives. Failing to take this amount of risk, and realize the returns that go with it, will doom you failure down the road, when it’s too late to recover.

But, what’s the harm is sitting out of the markets for short periods of time, when the risk of loss seems the greatest, if it makes us feel more comfortable, you ask?

First, your comfort is based on your perception, rather than reality. While you might be confident that the market is over-valued, there are thousands of professional investors who disagree. If they didn’t think the prices of securities fairly represented their value, the prices would quickly fall. You’re basing your decision to be under-invested on nothing more than intuition.

Second, the practical aspects of market timing make it nearly impossible to succeed in the long run. If you’re under-invested, you must, by definition, return to being properly invested or be doomed to failure in the long-term. If you’re out of the appropriate markets, you must, at some point, get back in. When will that be? What if your reinvestment trigger is never reached? Is one timing decision all you’ll need, or will you have to make them over and over again? What are the chances that you’ll beat the pros in capturing market-beating returns over and over again? Everyone can’t beat the market at the same time.

When only the possibilities are considered, market timing might seem like an attractive tool for managing your portfolio, but it’s clearly nothing better than a sucker’s bet — one you’re more likely to lose than to win.

Mike Miles is a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Ashburn, Virginia. Email your financial questions to fedexperts@federaltimes.com and view his blog at blogs.federaltimes.com/federal-money.

TSP investment

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Q. My daughter is 20 and just entered the military, hopefully to make a career of it. She is contributing 10 percent to her traditional TSP and $25 per month to her Roth TSP. Her traditional TSP is fully invested in the G Fund (this was automatic and she didn’t know enough to change anything). Wouldn’t it be better for her to put the maximum amount she can afford into the Roth TSP before putting anything into the traditional? She will probably be making quite a bit more money when she retires than what she makes now. If not, what is your suggestion? If she keeps the traditional contribution, should she redistribute her fund percentages or just switch to one of the L funds that are managed for her? Read the rest of this entry »

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TSP setup

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Q. I was recently hired at the the FDA. I have about $43,000 in student loans with a high interest rate. How much should I set up to be put into my TSP in order to take a loan from myself? Would this be a smart move? I believe that this way I’ll take out a loan from myself at a lower interest rate. Read the rest of this entry »

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Beneficiary IRA account

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Q. My mother recently passed away and left me $30,000 from her traditional IRA. Can I transfer this to my TSP? Would there be any penalties or tax hits?

A. Special distributions rules apply to a Beneficiary IRA account, and it is not eligible to be transferred into your TSP account.

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TSP eligibility

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Q. I am a firefighter with a county department, and also prior military. Since being discharged and starting my new career, I haven’t been able to figure out how to continue investing money into my TSP. Am I unable to do so, now that I am out of the armed services? Or am I just not looking in the right place? Read the rest of this entry »

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TSP risk

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Q. I am 25 and just started my TSP and want to invest in a very risky fund. What would be best for risky? Or should I take a different approach or is risky fine for someone my age? I am a risk-taker in life. Read the rest of this entry »

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