Tip: THE DANGER ZONE
This information is especially important for you to think about as you get closer to retirement.
The first thing to remember as you get closer to retirement is that the objective is not about making more money. Hopefully you have made plenty of money in the last 20 - 30 years of your public service, so that you can have a comfortable retirement.
The real emphasis is to protect the money you have already made. Your TSP will keep making money for you for many years but now one main thing will have changed for your TSP during retirement. You will no longer be putting in contributions! So that means more money in your pocket but on the flip side it also means if something were to affect your TSP, like a large Stock Market downturn or crash, you would no longer have a “cushion” of money to be able to inject into your TSP to prop it back up!
This is not a theory but just plain mathematics. There are several issues to consider for this dilemma but fortunately there are solutions.
One major advantage we have right now is that the general consensus of most economists and financial strategists is that there will be a Stock Market decline in approximately 1 - 2 years. Most of the time no one sees these Stock Market declines coming. No one. So this is a major decision moment for most investors.
They can either not pay attention and keep being aggressive with their investments or perhaps start slowing down and protect their investments. At least until the downturn has passed.
Stock Market declines are nothing new but since we now know about this one ahead of time there are two things we must consider. One is that no one knows how bad it will be and no one knows how long. Those are the two million dollar questions.
For people that are almost at retirement or have retired, this is an especially sensitive moment. My calculations indicate that the single most dangerous time for the TSP investor is the first 10 years of retirement! This is what I call, “The Danger Zone,” and it is brutal and unforgiving.
A large Stock Market downturn can permanently affect the next 30 - 40 years of your TSP funds. By large I mean 20%, 30%, or 40%. During the 2008 crash, the C,S, and I funds took a 40% reduction! If you have 10 years left before retirement and you are maxing out you contributions regularly, then there is a good chance to get back or increase where you were before the crash.
But if you are just about to retire or just have retired, you may not be able to get back and your TSP funds could realistically run out in 15 years, or you else you will have to scale back the money you are taking out of the TSP. If you were taking out $4,000, $5,000, or $6,000 a month, now you can only take out $1,000 or $2,000 per month. That is a big difference and a shame since you spent so much time saving for retirement.
Stock Market downturns statistically happen about every 5 to 10 years. That is not something new but by being in a reasonable fund, you can minimize the affects of the crash and still keep your TSP in healthy condition. This is true for most people in the pre-retirement phase. But for those about to retire or just retired, especially since we know a crash may be coming in the next 1 -2 years, there are steps to protect yourself and this doesn’t have to be painful on your retirement funds.
Just to put things in context, if you do get affected by the crash and you get a 40% decline in your TSP funds during the first 10 years of retirement, then you will have to get approximately a 12%-15% return every year for the next 8-10 years to get back to where you were. This is not good. It is very hard to do this every year for 8-10 years in a row even if you stay in the C, S and I funds exclusively.
Even if you decide after the 40% crash to hide in the L-Income fund or the G fund, you will not be able to recover your funds. You only get a 1%-2% return in the G fund and the L-Income is at about 4%-6%. This is not enough to get back.
You will have to get 12%-15% every year or like I said before, you have to scale back your TSP distributions to a much lower level. If the Stock Market crash makes a 30% decline, then you have to get about 9%-10% return every year for the next 8-10 years in a row. If you have a 20% decline, then you have to get about a 7%-8% return every year. You get what I mean. These are painful ways to spend the first 10 years of your retirement. You don’t need this stress and there is a way to keep things in check.
A reasonable rate of return for the post-retirement phase is approximately 4%, 5% and 6%. 4% is minimal, 5% is reasonable, 6% is optimal. This is what you can expect from the L-Income fund or the L2020 fund or even in the last five years or so of any particular L Fund. That is the way these funds work: From aggressive to conservative over time. If you are in these funds during the Stock Market crash, by definition they are diversified and a more conservative profile, so their risk is less and they will not lose as much.
The L-Income fund lost about 5% during the 2008 crash. You can make back a 5% loss during retirement. You can even make back a 10% loss. Once your losses start reaching 12%, 15% or more, then it does not look good to recover to where you once were.
There are two avenues to think about if you do protect yourself in the L-Income fund or the L-2020. At approximately mid December 2020, the L-2020 defaults into the L-Income. One option is to stay in the L-Income fund if it provides you with enough growth for your future retirement needs. It can and it will always provide you better protection from the next Stock Market crash in the next 5-10 years. That’s one way to relieve the stress of worrying about your TSP during retirement.
Another course of action is to wait until the Stock Market downturn is over, hopefully around mid 2021 or 2022, then move your funds to the L-2030 fund for approximately 10 years until this fund expires, then move it into the L-2040 for 10 years, then the L-2050. By doing this you are fairly well protected and you receive about a 5%-6% pre-retirement rate. Not a bad plan if you don’t mind moving your money around every 10 years.
It depends on you and your comfort level. Leave it in the L-Income and go on auto-pilot or make a few adjustments every 10 years. If the TSP comes up with any new L Funds, like a L-2025 or L-2035, then you can even adjust the funds every 5 years for a more consistent return. That’s up to you. The main thing is you won’t experience anything near the devastating affects of a 20%, 30% or 40% possible loss on your TSP.
If you want to go back to your C, S and I funds after the crash, then that’s up to you too but you really have to think about this. Is it worth it to try to make more money in the C, S and I funds if you could lose up to two-thirds of your retirement TSP on the next Stock Market crash?
Even if you achieve the 9%, 12% or 15% returns every year in those first 10 years, you can get hit with another Stock Market crash unexpectedly. Every 5 to 10 years a Stock Market crash occurs but no one knows exactly when or how bad. That’s a large window of time to be vulnerable. It’s almost like trying to fight the current in the ocean with wave after wave crashing against you. The current will take you eventually.
I will put this in context as well: When you drive a vehicle, you put on your seatbelt. Maybe you decide not to put on your seatbelt because it is too restrictive for you. Maybe you don’t get into an accident ever or maybe for 20, 30, or 40 years you are accident free. Then one day a drunk driver hits you or you just make a mistake. Maybe it’s a fender bender or maybe a head on collision. Do you think the seatbelt would help you? Do you want to take chances like that with your TSP funds?
Be careful and think about this. Stay out of the Danger Zone.