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Follow the Crowd With Your Investments–and Plan on Working Until You Die

TSP investors need to be smart about investing their retirement funds. Following the latest trend can lead to poor financial results and a poor retirement

Americans are obsessed with retirement according to SmartMoney magazine. It affects us personally. It’s our future. Many of think it’s our due-we worked hard and we earned it. But being able to retire, let alone thinking of retirement as an entitlement, is a recent phenomenon. Our grandparents didn’t expect to retire. You worked until you died or were too ill to work. Retirement plans didn’t exist unless you could sell the family farm for enough money to live on.

In the 1950’s people began thinking of an active retirement for the first time. Money for retirement was to come from a funded pension plan. The company funded a plan and you knew in advance about how much money you would have for retirement based on the number of years you worked for the company and your salary level. (If this sounds like the Civil Service Retirement System (CSRS), it is.)

In the 1970’s and ‘80’s retirement evolved and with the advent of 401(k) plans, people assumed responsibility for their own ability to retire. This system gives each individual more freedom. The system is portable so you can take it to another employer; you don’t have to work for one company for 30 or 40 years to retire. It also shifted the risk for investing the money from the company to each individual (in other words, it’s like the FERS system for Feds).

A large number of Feds in the CSRS system are retiring or want to retire in the near future. Many people in the newer FERS system won’t get there for a few years.

Some FERS employees will do very well under this system. Many will not. In fact, a number of FERS employees are putting little or no money into the TSP system. These people probably won’t be able to retire or at least not retire with a lifestyle anywhere comparable to what they have as active employees. They are reverting back to our grandparents system of retirement–work until you die. And it isn’t just Federal employees. Private sector employees are bailing out of their retirement plans also as the bear market in stocks continues to devour employees’ retirement funds for the past three years.

What about the rest of you? Will you have enough money to retire? Will you bail out of the TSP system because you can’t stand to see your investments declining in the on-going bear market?

Even if you invest the maximum amount you can into the TSP program, some people won’t have enough money to live on after they leave government service. The reason is simple: they invest like idiots. That is a harsh assessment but there is a basis for it.

Here’s why. To take an eye-popping example from University of Pennsylvania finance professor Jeremy Siegel, how much would $1 invested in various financial instruments in 1801 be worth in 2001? The results should tell you something.

Your stock investment would be worth $599,605; bonds $952; T-bills $304 and gold, $0.98 (the amounts have been adjusted for inflation). Obviously, despite wars, inflation, depressions, and various disasters, stocks did much better in the long run.

No one can predict the short-term performance of stocks or bonds. But, having said that, anyone can step back and look at long-term trends and make a reasonable assessment of what is occurring. The mistake that most people make is to assume that what is occurring now will continue to happen in the future. For example, stocks are declining in a bear market. There is no reason to assume they will go back up again. Or, conversely, stocks have been going straight up for several years. Why should they start going down now?

This approach to investing will cost you a lot of money.

Here is a good example. At the absolute peak of the stock market bubble in early 2000, record amounts of money were taken out of money market funds and put into stocks and stock funds. There was, of course, lots of encouragement from brokers and others telling investors that just because the stock market indices had tripled in six years didn’t mean they should turn cautious. One analyst said at the time the market was peaking that “opportunity is so huge that you have to own (tech stocks).” Presumably, some of his clients took his advice and bought stocks selling for $150 and more per share only to see them fall to under $10 in the last three years.

The market and the public were filled with unbridled optimism. That happens at the top of a bubble. That is probably why people took out record amounts from money market funds and invested in stocks at the most inopportune time.

Feds are following the usual trend that investors follow. In 2002, investors transferred about $5 billion out of the C fund. Most of this went into the G fund and a smaller amount into the F fund as investors sought to minimize risk. I anticipate we will see this trend intensified in the first part of 2003 and will probably peak just before the market starts to go up again.

So what does this mean for you today? How should you invest your money?

First, don’t fall into the trap of thinking that because the stock market has gone down that this is a good time to bail out of stocks. Stocks have provided the best investment return over other investments for many years. If you do not have some of your TSP funds in stocks, you are likely to miss out on the gains that have always come from this investment.

Second, don’t assume that investing in bonds protects you from risk. Risk takes different forms. You may lose money by not taking part in significant moves upward in the stock market. For example, the G fund is a very safe mutual fund and it is only available to Federal employees. It is a great investment vehicle.

When you retire, you may need more money than you think. You won’t get a yearly increase that exceeds inflation as you often do as a full-time government employee. There are no within-grade increases and no more promotions. And, as retirees have discovered in the past several years, the increase in your health insurance premiums may exceed your cost of living increase.

You don’t want to outlive your financial resources. The G fund may not give you enough of a return to enable you to do this. Obviously, each person is different. If you have a few million to invest or another source of income this may not apply. Get advice from your retirement counselor or financial advisor.

Also, contrary to a view held by some investors, the F fund can go down. It has been an outstanding retirement vehicle, particularly in the past three years. How can it go down?

A bond fund obviously owns bonds and these bonds pay interest. If the fund has a bond with a face value of $10,000 and it pays 4% interest, that is a safe investment with a predictable return. But what happens if interest rates go up and new bonds are paying 5% interest or more? The value of the first $10,000 bond goes down. No one will buy that bond unless it is sold for less than its face value. The fund may hold it until it matures and get the full value back. But the value of the fund has gone down and the fund has collected less in interest than being paid by current bonds. Assets in a fund are valued each day. If interest rates go up, the value of the fund goes down. If interest rates go up a lot, the bond fund may go down a lot.

Stocks are a lot less expensive now than they were three years ago. Bonds are much more expensive than they were three years ago. Interest rates are low and returns on bonds are also low as a result. The stock market has been going down for three years. We are facing a war in the Middle East with unsure prospects for the future.

In short, no one can predict the future. Looking at the investment climate from a broad perspective, this is not a good time for investors to abandon stocks and put all of your investment money into bonds. There are certainly exceptions to this but people who bail from stocks now are likely to reduce their financial returns over the next several years.

Decide how to allocate your investments. For example, after talking with your financial advisor or retirement counselor, you may decide to put 45% in the F fund, 45% in TSP stock funds and 10% in the G fund. Rather than reacting to swings in the market, put your money into the funds that give you this allocation and periodically adjust it. (This allocation may vary dramatically depending on your situation; I have only given it as an example, not as a model to follow.)

Having a sound plan that you have thought out and then having the discipline to follow it should enable you to have a comfortable retirement. Let those who are foolish enough to try and guess the next short-term market moves or those who panic in the latest trend spend their money and brag about their latest returns. In the long run, your returns will come out ahead and you can actually enjoy your retirement.

About the Author

Ralph Smith has several decades of experience working with federal human resources issues. He has written extensively on a full range of human resources topics in books and newsletters and is a co-founder of two companies and several newsletters on federal human resources. Follow Ralph on Twitter: @RalphSmith47