We all have heard that we should invest aggressively while we are young and then be more conservative as we get older and approach retirement. But for many, it can be hard to know what this actually means in practice.
In this article, I’ll share my strategy and approach to ensure that my clients are taking enough risk as they approach retirement while also being conservative enough so that their money is there when they need it the most.
Time Is Everything
One of the most important elements in investing is time. The more time you have before you need your investment funds, the more risk you can afford to take because you have time to ride out the market swings. As you get closer to the time that you’ll need your Thrift Savings Plan (TSP) to live on (aka retirement), you will want to make sure that that your short-terms needs are always covered regardless of what the market is doing.
Some people “solve” this issue by putting all the TSP money into the G fund as they approach retirement. While this does lower the chance of their account dropping dramatically with the market, it also increases the chance that your money will run out in retirement because of the lack of growth.
For most federal employees, it makes sense to have a more balanced approach to have stability for their short-term needs while also having enough growth to ensure a long retirement.
The hard part is knowing how much of your TSP you should be conservative with and how much of it you should invest more aggressively.
To answer this question, we’ll have to answer another question: How much of your TSP will you need and when? This question is answered once we know what your net income (after taxes and reductions) and expenses will be in retirement.
For example, let’s say you calculate your net pension (after taxes, FEHB premiums, etc.) as $2,000/month and your net FERS Supplement as $500/month. This means that before you start Social Security, your net income will be about $2,500/month in retirement. If we estimate your retirement expenses to be $4,000/month, that means that you need about $1,500/month or $18,000/year from your TSP to maintain your lifestyle.
Note: If you only have money in the traditional TSP, you will have to take out more from the TSP than you actually need because you will owe taxes on the withdrawals. For example, you may have to take out $20,000 each year to end up with $18,000 after taxes.
Knowing how much you’ll need from your TSP every year is crucial because then we’ll know how much money we’ll need to invest conservatively to make sure you have your short-term needs met. As a rule of thumb, I want my clients to have 3-5 years of expenses that their fixed income doesn’t cover in short-term bonds (things similar to the G fund and/or F fund). This strategy does two things:
- It ensures that their short-term needs are taken care of.
- If the market was to go down (which it will), they have enough cash to ride our market swings.
The next 5-7 years of their retirement expenses are going to be invested in long-term bonds and some stocks. These investments provide growth and dividends to replenish the lower risk investments as they withdraw money.
Any funds that are going to be needed over 10 years away will be invested in longer-term investments that will provide good growth over time while also protecting against inflation.
How To Apply It
As you approach retirement, the first thing that you should find out is exactly what your projected income and expenses will be; just make sure you know how much of your income you’ll actually be able to spend after taxes and deductions come out of it.
From there, you’ll have a much better idea of how much money you will need from your TSP and what investment strategy makes sense to ensure that that money is there for you when you need it.