How do you invest in the TSP within your comfort level? How are you seeking to maximize your return while minimizing investment risk? How much investment risk are you willing to take to have the potential for a higher return over the next 12 months?
On the TSP risk scale, the G Fund is the only fund that guarantees you won’t lose principal. The F Fund is a bond index and has done very well historically, however it is sensitive to rising interest rates which could cause the value to decline. The C, S, and I Funds are equity funds, and with the exception of the I fund have historically outperformed the G and F Funds.
|Year||G Fund||F Fund||C Fund||S Fund||I Fund|
|10 Yr Compound||2.63%||4.59%||7.00%||8.13%||1.02%|
The chart above from www.tsp.gov provides the 10-year annual return summary of the five TSP funds.
In looking at the G Fund, you can see that there were no negative return years during this time-frame. The range of returns in the most recent 10-year period was 1.47% to 4.87%.
In comparison, let’s look at the S Fund, which in 2008 had a loss of (38.32%) and in 2013 had a gain of 38.35%. That is a pretty wide swing.
Why Does Investment Risk Matter?
Imagine two portfolios. Portfolio 1 is up 60 percent in the first year, and down 40 percent in the second year. Portfolio 2 is up 30 percent in the first year and down 10 percent in the second year.
Both portfolios have the same total return (and average return) over the two years.
Portfolio #1: +60% – 40% = 20%. Over two years, this equals 10% per year.
Portfolio #2: +30% – 10% = 20%. Over two years, this equals 10% per year.
However, when we do the math, we find very different outcomes.
- $100,000 invested after one year = $160,000 (60% of $100,000 is $60,000)
- $160,000 after year two becomes $96,000 (40% of $160,000 is $64,000)
- $100,000 invested after one year = $130,000 (30% of $100,000 is $30,000)
- $130,000 after year two becomes $117,000 (10% of $130,000 is $13,000)
Portfolio 1 had a range of 100% (+60% to -40%). Portfolio 2 had a range of 40% (+30% to -10%).
A smaller range or less risk, led to more money.
This is a hypothetical example provided for illustrative purposes only; it does not represent a real-life scenario, and should not be construed as advice designed to meet the needs of an individual’s situation.
Understanding Investment Risk is Key
Recognizing how risk affects the growth of money is key to helping you achieve your goal of maximizing returns while minimizing risk. If you compare two portfolios with the same average return, the one with less risk will always lead to higher returns. It’s just MATH.
This is especially essential the closer you are to retirement. And for those of you that are in retirement, taking withdrawals from your TSP or IRA, it is even more critical. Participating in a volatile downturn while taking distributions can be a double whammy.
Narrowing the Road Concept
There are several ways to analyze your portfolio to determine if your particular investments are in line with your comfort level.
We take the approach of managing a road. The center line is the average return the portfolio may have earned over the past 10 years. The upper boundary of the road is the “best year” and the lower boundary is the “worst year”. We utilize a software through Morningstar to give us a snapshot. If you are looking for lower volatility in your TSP or other investments you want to keep the road as skinny as possible and the average center line as high as possible.
Let’s use a hypothetical couple, Harry and Judy, to show you how this works:
Harry and Judy have around $565,000. Harry would like to work for two more years, and he is contributing the maximum to his TSP. Based upon a 5 percent return, they determined they would have enough money to retire at his goal of two years. This assumes that they earn a consistent 5 percent each of the next two years.
When we look at our snapshot, we see that Harry and Judy have earned an average of 5.62 percent over the past 10 years. This sounds good because they only need to earn 5 percent to be able to reach their retirement goal.
If we look at the best year and the worst year, we see that their best year was +41 percent. Very nice!
However, we find that during their worst year they lost 32 percent. Now if they were able to reduce the range from best to worst and maintain a similar average, they would be able to be more confident in achieving their goals.
- BEST YEAR: = 41%
- AVERAGE: 5.62%
- WORST YEAR: -32%
Reduce Range from Best to Worst
- BEST YEAR: +16%
- AVERAGE: 5-6%
- WORST YEAR: -5%
Now imagine if the really bad year (-32%) happened close to the time of Harry’s retirement, or worse, in the first year that he began taking distributions. Things might not go very well for them.
Allocating TSP or other investments should be matched to an individual’s comfort level. Many investors are comfortable with higher risk. My thoughts are that if you’re ahead of the game (you have reached or just about reached your retirement goals and objectives), do you want to risk having a game changer.
Securities offered through GF Investment Services, LLC. Member FINRA/SIPC. Investment advisory services offered through Global Financial Private Capital, LLC.