With the markets performing as poorly as they have lately, we’ve been getting lots of federal employees asking us if they should continue contributing to their TSP. Many people are concerned about making contributions only to see their TSP values dropping as soon as they invest their money.
It’s a great question and we’ll explore what TSP participants need to consider when making the best decisions for their family, as well as the one circumstance where you may want to slow down or possibly stop your TSP contributions altogether.
Down Market = Loss of Value?
The common reasoning behind this question is that many people wonder why they should put money into an investment that keeps losing value. There are a few reasons for doing so as it relates to retirement account contributions.
Provided that you have strong investments, like ones offered inside the TSP, you should be thinking about a drop in the markets as a sale on investments in the stock markets. It sounds a little ridiculous, but if you’re still working that means you may still have some time and that you’re a long-term investor.
What’s the likelihood that those investments will go back up in value? If you believe they will, wouldn’t you want to purchase them when they’re lower in value? This is called being “bullish” about the markets or investments writ large. The inverse, when you feel negatively about an investment, is called being “bearish”. Understand that not all investments recover their lost value. No company, including very large ones like S&P 500 companies (C-Fund), are guaranteed to be invulnerable to some sort of economic disaster. 2008 was a prime example of this.
But you need to measure your risk in your portfolio and determine whether it’s acceptable relative to your goals. The more growth potential there is, the higher the risk both in volatility (price fluctuation) as well as the potential for permanent loss. Being diversified helps spread out the risk of any one company going under.
There’s a simple strategy in portfolio management called Dollar Cost Averaging. This is when an investor slowly makes purchases of investments in smaller amounts over time rather than a large sum all at once. Wealth managers will use this strategy during volatile markets to deploy cash because it allows investors to get a better overall average price of all their investments together. We use this strategy with our clients, and it has the potential to be extremely successful if you do it correctly.
You also must remember that by continuing to make TSP contributions, you’re also continuing to defer taxes on your salary and the growth of investments if you’re using the Traditional TSP, and you get to the opportunity to participate in tax-free growth if you’re using the Roth TSP.
Even if you employ the dollar-cost-averaging strategy, there is always the potential that the markets will keep falling, and that your contributions will fall in value too. But since you’re not yet retired, this volatility is less of a risk to you.
If you are retired, you can’t make contributions anymore, and volatility is absolutely a big risk to you. We won’t get into the details because that’s a separate retirement planning discussion, but just understand the concept.
When To Consider Stopping TSP Contributions
There is a circumstance where we do recommend that someone slows down their retirement account contributions. Given the current economic and market cycle, if you’re nearing retirement and your cash reserves are not close to at least 6-12 months of your expenses, you may want to consider slowing down your TSP contributions so that you are able to take more of your paycheck home and use that additional capital to build up your savings.
There are a couple of reasons for this: the first is that FERS retirement applications are backed up, so even once you retire there may be a period of time that your pension will not supply you with the cashflow you need.
The second, more important reason, is that in volatile markets, you don’t want to be selling from investments that have fallen in value to generate your needed cashflow. It’s imperative that federal employees understand that the TSP does not allow you to pick the fund from which to sell to take a distribution.
So, for your immediate cash needs, you really want to have enough in reserves to be able to access if needed. This is important even if you plan to move your TSP to an IRA, where you do have that level of control. Doing this transfer can take some time, especially if you still need to develop a proper plan surrounding your retirement and investment strategies first.
There is a delicate balance, however. Too much cash, especially in an environment like our current one with high inflation, will create a significant cash drag on your wealth. Inflation is the silent portfolio killer, and a portfolio not aggressive enough can struggle to support your lifestyle for your entire retirement. Simultaneously, a portfolio too aggressive at the wrong times can cause you to sustain greater losses than your financial independence can withstand.
Lastly, remember that changing your TSP contributions can impact your taxes, so make sure that you understand the impact of making that decision, and talk to your advisors before making any changes.