Ask The Experts: Money Matters

By Mike Miles

TSP allocation

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Q. I work for the Defense Department. I have $75 biweekly going into the G Fund. I am in my early 30s and want to build my money. I don’t see it moving much in the G Fund, and I have been investing for four years. I can afford to invest $100 biweekly but don’t know what fund to put my money in for it to grow. My annual income is $38,780.

A. Given your circumstances, I suggest that you invest all of your Thrift Savings Plan money in the L 2050 Fund for the foreseeable future.

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Full TSP withdrawal

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Q. I am 67 and retired. I made a partial withdrawal a few years ago. I need some cash for a family matter, so I want to make a full withdrawal now. I don’t want an annuity, but I’ll invest half in a commercial IRA or retirement instrument in hope of reducing the immediate tax impact of this full withdrawal. Can I do so? — that is, invest half of this full withdrawal in another commercial instrument, thus avoiding for now the tax on this “re-invested” amount?

A. Yes.

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S Fund to G Fund

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Q. I am 47, have been investing for seven years, have reached maximum contributions at a total of $115,328.22 and will eventually retire at 63.

Recently, there is talk in the stock market of a global sell-off. I have had all of my investments in the S Fund and doing quite well. As of Jan. 23, I’ve shifted my contribution of 100 percent from S to G. Was this a financially dumb move?

A. Not if you’ve guessed right. Only time will tell. For what it’s worth, if we’re talking about your entire portfolio here, you should be invested in all five funds, all the time.

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S Fund

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Q. I currently have all of my Thrift Savings Plan investments in the S Fund, and I see that it is now losing money. Should I move my money today or this week, or wait and try to recap what I lost (Loss is recent, I think over this past weekend)?

A. The person responsible for managing your investment strategy will have to make this call. I can’t tell you how to work the controls if I don’t know where you’re going, what you’re driving or how much gas you have in the tank. I can tell you that a portfolio composed only of S Fund is not risk-efficient and is bound to lose significant amounts of money from time to time.

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Variable annuities

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Q. I just retired from government service under CSRS and have left my Thrift Savings Plan alone. My financial adviser, whom I consider a friend, is telling me I need to roll my TSP over into a tax-deferred variable annuity that guarantees a 5 percent return on investment each year even when the market does poorly. He says because of this “guarantee,” I can choose a very aggressive growth portfolio, while not having to worry about the results.

He claims my TSP is not protected against losses. I knew that already, of course. It’s with a highly rated company. Fees are around 2 percent annually. I noticed you have a real problem with these kinds of investments. The market is due for a major correction. Why are you so against these annuities?

A. They are expensive insurance policies. Two percent is huge! You’re more likely to lose than to gain from investing in one of these things compared to a comparable investment strategy invested in the TSP. Ask your “friend” how much money he will make from your purchase, including commissions, bonuses, fringe benefits, etc. You are paying that compensation from your account, in addition to the insurance and other costs which are designed to make sure that the insurance company profits at your expense. You shouldn’t even think about investing in a variable annuity until you’ve read the prospectus and clearly understand exactly what you’re getting into.

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Return on annuity

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Q. What is the percentage of return if I invest the balance of my Thrift Savings Plan account in the annuity provided by TSP?

A. The monthly payment depends upon your circumstances and the interest rate environment when you purchase the annuity. You can run a quote at www.tsp.gov. The return on investment from a TSP annuity can’t be known in advance, however. You’ll have to wait until the payments stop to figure it out. To illustrate, what if you buy a single life annuity with no refund and then die right away? Your return on investment will be hugely negative. The longer you live, the better the rate of return.

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TSP withdrawals and investments

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Q. I am a civilian FERS employee who will retire this summer at age 59 with 35 years of civil service.  After retiring, I intend to start monthly withdrawals from my Thrift Savings Plan account ($2,000 per month). Even though I will have begun making monthly withdrawals from my TSP account, can the remainder of my money in the TSP continue to be invested in the various funds (G, C, F, S, I) and continue to grow via earnings within these funds?

A. Yes.

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Test your retirement financial fitness

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Are you planning to retire soon? If so, you’ll need to figure out whether you’re financially able to make it work in the near and the distant future. Because there are few, if any, truly reliable financial guarantees, this can be a difficult thing to determine.

The essential question is this: “Will I have the resources — usually cash — available when I need it to support my desired standard of living for the rest of my life?” If someone else is depending upon you for all or part of their financial support, your retirement decision will affect them, as well, and they should answer this question before you commit.

If you are relying solely on a CSRS annuity, or even Social Security, to support your living expenses in retirement, your job is fairly easy. Both of these income streams are fully indexed for inflation and guaranteed by the best guarantor there is. The most significant risk you have to consider with these is that the guarantee you’re counting on might fail. While this may seem like a large risk, it is relatively small when compared with the risks associated with other potential income sources, like FERS and private annuities, and withdrawals taken from an invested portfolio. These risks include loss of purchasing power, insolvency, reduction in benefits, and market and interest rate risks. Assigning probabilities to these risks and analyzing their potential effects on your retirement plan is beyond the ready ability of most people who don’t specialize in statistical analysis. So, what can you do?

Start with this basic test. Add up the sum of your guaranteed retirement income streams from such sources as CSRS, FERS, Social Security and other defined benefit pension plans.

Then do some research to see what kind of payout you can expect to receive if you used all of your savings and investments to purchase one or more inflation-adjusted guaranteed fixed immediate annuity contracts.

Make sure that you choose the maximum inflation adjustment rate available when requesting the quote. The Thift Savings Plan website has a calculator that will give you a quote, on the spot. Add this guaranteed annuity income to your other guaranteed income to find your total pretax guaranteed retirement income.

If this is enough to meet your expected cost of living, after deducting an allowance for taxes, then you can probably safely retire.

If not, you should investigate your options further to see if an alternative approach might be workable.

With annuity payouts near historical lows, the invest-and-withdraw option, if managed prudently, will probably support a higher standard of living and produce better results — at least until the payout rates rise significantly.

Here’s a sample test calculation based on three guaranteed income sourses — FERS, Social Security and TSP:

FERS annuity: $30,000

Social Security: $20,000

TSP annuity payout with increasing payments on $200,000: $10,000

Total guaranteed pretax income: $60,000

Less 25 percent allowance for taxes: -$15,000

Total guaranteed after-tax income: $45,000

After-tax cost of living in retirement: $40,000

Test result: Fit to retire.

This test is not conclusive, but it is a good starting point in determining your financial fitness for retirement.

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TSP allocation

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Q. I’m 32 years old, have been contributing to the Thrift Savings Plan since 2005. I have 40 percent in my C Fund, 30 percent in S and 30 percent in I. Is this a good contribution allocation? I want to be as aggressive as possible, but I am also looking at moving most of my gains to the G Fund due to the fact the market may be headed in the same direction as 2009. If I want to protect my gains with the means of buying back at a lower price, what would be your recommendation be on rebalancing the money in my account and adjusting percentages on new money coming in?

A. You’re asking me how to implement your investment strategy. If you don’t know how to manage it, why are you using it in the first place? What do you know about that asset allocation you’re using? How is it likely to behave? What is its expected return? What is the standard deviation of those returns? How do these characteristics support or threaten your lifetime financial plan?

As I’ve pointed out many times, your question is like asking me how work the controls on your care without telling me where you are, where you want to go, what stops you want to make along the way, when you’d like to get there, what kind of car you’re driving or how much fuel you have in the tank. Your investment tactics should be based on an investment strategy which includes cash reserve and asset allocation targets, securities selection and transaction timing algorithms.

I don’t manage portfolios the way you are managing yours because there is too much uncertainty that could be avoided. The best advice I can give you is to recommend that you identify the investment allocation that will support your lifetime financial goals with a minimum of risk and then rebalance to that allocation on a regular fixed schedule — at least once per year and not more than four times per year.

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Focus on the future, not the past

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Here are the five basic Thrift Savings Plan funds in order from the highest to the lowest rate of return for the month of October: C Fund (4.60%), I Fund (3.38%), S Fund (2.94%), F Fund (0.89%), G Fund (0.19%). And here are the year-to-date results: S Fund (31.13%), C Fund (25.34%), I Fund (19.43%), G Fund (1.52%), F Fund (-0.78%).

Interesting? Maybe to some. Useful? I don’t know how.

As an investment manager — or TSP participant, as you are more commonly known — you are responsible for making, or delegating the making of, a massive series of decisions. Some of these decisions, like whether you contribute to the Roth or the Traditional TSP accounts, will most likely wind up being relatively insignificant. Others, like the distribution of your money among the available funds, will be instrumental to determining your financial future. As I’ve written before, making sure that the important decisions are the best they can possibly be is your primary objective as an investor. If you’re not sure which are the critical decisions, you’d be safe to make sure that every decision you make is the best it can be.

This brings me back to the question about the usefulness of historical performance data for the TSP, or any other, investment securities. Is it of any real value? I don’t believe it is. There is no strong evidence that this information, at least in the short run, is useful for predicting future results. You can’t go back and make decisions based on it. So, what good is it? Really, it’s no good at all. In my experience, it causes problems and leads to bad decision-making.

Two wrong-headed mistakes are often made. The first is the incorrect belief in the “due theory.” This is the fallacy that the probability of an independent event occurring goes up as the event does not occur: “I’ve just flipped 10 heads in a row, so the odds of flipping a tail on the next try are greater than 50 percent.” Not true!

The second, and I think more common, mistaken belief for investors is the momentum of inertia theory. This is belief that an independent series of events is likely to continue on its current path: “I just flipped 10 heads in a row, so the odds of flipping a head on the next try is greater than 50 percent.” Wrong again.

Sure, you can find historical records that support either of these theories, but that doesn’t mean they make any sense. You can find support for just about anything through back-testing large, randomly generated data sets, and a series of unpredictable events often shows surprising runs of luck, good or bad. Patterns appear to show up just about anywhere you look for them, even in random data.

Finding a pattern in history and predicting one in the future are two very different things.

As an investment manager, your job is to be concerned with two things: Where you are today and how best to get where you want to be in the future. While the past has put you where you are today, you don’t need to know anything about the past to assess your current position. And the kind of historical data published for specific investment securities, like funds, is not needed for use in making decisions about how to proceed in the future. In short, this information is useless to you in managing your TSP account or any other investment account.

Even the effect historical data tends to have on investors is unreliable, if not outright dangerous. Many of the investors I’ve talked with over the years tell me they feel great when their account values have risen quickly or steadily to a new high. Likewise, they feel bad when their account values have fallen. These effects tend to make them want to invest more, or more aggressively, on the heels of good market results and withdraw their money from risky assets after bad results. Data on investor behavior confirms this behavior. Unfortunately, it is irrational and harmful. It is rational to become more cautious as prices and values rise, and more confident in your investing as they fall. The key to successful investing lies not in tracking the price history of investment securities, but in understanding and accommodating the probabilities of their future prices. Done right, it is a prospective, rather than a retrospective, exercise. So, it’s OK to be entertained by what happened yesterday. Just don’t make the mistake of confusing this with what will most likely happen tomorrow.

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