Individual investors have an important advantage over professional investors. It is the individual investors’ time horizon.
A time horizon is one of the key elements in picking a specific overall asset allocation and risk level. One of the first steps in determining your portfolio allocation is to determine your time horizon.
Each of us has different investing goals: retirement, paying for our children’s college education, or building up a home down payment. Typically, those who invest in short-term investments don’t want to take on as much risk, while those who have longer time horizons may be willing to take on more risk.
Retirement planning requires us to focus on long-term investing. Typically, long-term investing means five years or more, but there’s no firm definition. By understanding when you need the funds you’re investing, you will have a better sense of appropriate investments and how much risk you should take.
Disadvantages for Professional Investors
Professional financial intermediaries have a disadvantage compared to individual investors when it comes to managing assets for the long term. They are competing against other professionals.
This occupational competition creates possible conflict by emphasizing short-term performance to sustain their client investors’ confidence to attract and retain them. Transaction costs aggravate the issue and the periodic short-term adjustments can drive high portfolio turnover. Clients sometimes allow today’s headlines to govern their emotions.
Short-term investment decisions therefore may be under pressure because of long-term underperformance. This may cause financial managers to engage in window dressing or style drift.
It can also occur from a change in the fund’s management or a manager who begins to diverge from the portfolio’s mandate. Professional long-term money managers can become hostages to quarterly, annual, three-year, etc. periods used as metrics to validate their expertise and performance.
Challenges for TSP Investors
The challenge for the individual investor in the Thrift Saving Plan (TSP) is to avoid the bad decisions professionals are sometimes tempted to take that can drive underperformance.
Index funds such as the TSP’s Lifecycle Funds enjoy lower risk through diversification of assets and low expense ratios. They are considered passive investments. Passive investing is a buy-and-hold investment strategy for a long-term investment horizon.
The TSP offers low expenses for all its Fund choices. The Lifecycle Funds gradually rebalance and reallocate your assets at no additional cost as you get closer to retirement.
Each of the Lifecycle Funds, except for the L Income Fund, automatically adjusts every three months, gradually shifting them from higher risk and reward to lower risk and reward as they get closer to their target dates. The L Income Fund is designed with the purpose that your investments have reached the year in which will now need greater liquidity for withdrawals but will still need to preserve some growth to sustain your retirement for years to come.
For example, if you are 25 years old in 2023, your time horizon may encompass 40 years between now and 2063. Earlier in your career, you’ll need to accept greater risks with your investments to accelerate your growth and feel comfortable enough to leave the workforce at the end of four decades.
The TSP is Not Your Emergency Fund
At the same time, you as an individual investor do not have the luxury of avoiding the reality of having to confront financial situations which demand liquidity before retirement. People sometimes use the TSP to address both their long-term retirement savings goal and the liquidity of an emergency fund by populating their TSP with one of the Lifecycle Funds and the G Fund.
Your TSP account should be used solely for your retirement planning. Apportioning some of your TSP savings to serve as a source for long-term retirement and as a source of emergency funds is not a wise move for several reasons.
First, selecting which funds are sold when you withdraw from the TSP is impossible. If you have a portfolio of 50% 2065 Fund and 50% G Fund and a withdrawal of $10,000, the TSP will sell $5,000 of the 2065 Fund and $5,000 of the G Fund. You may have to pay a tax penalty of 10% in addition to the regular federal income tax for accessing the TSP savings.
Second, the short-term timing of the withdrawal may be at odds with the economy and other factors.
An emergency fund provides you with the confidence to dedicate your retirement savings solely on a long-term basis. A money market account or a series of certificates of deposits are the proper investment choices when liquidity is a priority. The TSP is not designed for serving as a source of your emergency fund.
If you act as your financial planner, use the TSP solely for your long-term retirement savings. Open up a separate account at a credit union or other financial institution for your emergency fund.
