Tip of the Month: New TSP Ideas to Consider
After a year examining what affect the Covid had on the TSP, I have realized some new ideas. Unfortunately it took such a sad event like the Covid to produce some extraordinary analysis of the TSP but I was able to use the last year to create some pretty specific models to test some theories on how to generate larger returns for the TSP during pre-retirement.
One major accomplishment was a deep analysis of the C Fund and how it could be used to generate a significant increase in gains. This analysis comes with pros and cons on how to use the C Fund effectively. I finally was able to determine that people who talked about putting a lot of your money into the C Fund were right. It can be used safely for your TSP growth but there is a catch, which we will discuss.
The C Fund is a combination of the 500 largest companies in the stock market, which comprises about 80% of the stock market. The S Fund is a combination of the other 20% of the Stock Market. The I Fund is the international funds market with a mediocre record.
New idea #1: You can not lose all your money in the C Fund because by definition, since the C Fund is composed of 500 companies, all 500 companies cannot go bankrupt at once. Maybe one or two of those companies will go bust at some time but statistically all the companies will not. If they did, then civilization would stop as we know it. There would be no food, no oil, no electricity, no cars being manufactured and no airlines. Everything would stop, which is really one of those Armageddon situations you see in those horror movies on television. That is not going to happen.
That doesn’t mean that it would not be painful to lose money if one of the larger companies went bankrupt. It would but there is a way to protect yourself nevertheless.
In 2008, the C, S, and I funds lost approximately 40% during the Great Recession. That was unbelievable and very painful. That was also a Super Event. That doesn’t happen very often. The last Super Event was the Great Depression which was about a 75 year gap. All the other Stock Market crashes were much smaller and occurred about every 5-10 years. Some were more significant than others and some were more painful but they were not Super Events. Hopefully we won’t have another Super Event for another 50 years, so in our lifetime we probably won’t see it happen but our children will probably experience it.
Even with a Super Event, the C, S, and I Funds did not implode. A 40% loss is very tough to go through but these funds recovered in about 5 years. That’s because the Stock Market is still very effective at countering all the issues that made it decline in the first place.
The other big part of this recovery is that as a pre-retirement person, you are still putting contributions into the TSP and that was a very important factor for your TSP to recover. It acts as a cushion. If you are post-retirement, this analysis does not quite apply since you are longer making contributions to your TSP but we will discuss other strategies later in the blog.
There are several financial people out there that say, “Put all or most of you money in the C Fund and let it ride,” Well some of this guidance may be right and it may be wrong. Here’s why:
Funds like the C Fund produce very big returns but also big losses. It’s a roller coaster but It is still quite impressive. Even with the Covid, the Stock Market C still did very well in 2020. About 25%. The C Fund is also quite diversified. Being invested in the 500 companies of the C Fund that provide different goods and services in many different industries is a very good way to protect your money. If you throw in the fact that many of these companies do business overseas, you don’t even have to consider the I Fund, which will not be considered for the rest of the analysis. The S Fund is made up of the smaller companies in the Stock Market that don’t go in the C Fund, so that produces an extra return if the TSP investor is interested in covering the whole Stock Market. Your mix of C and S Funds would probably look similar to the Stock Market mix, 80% in the C Fund, 20% in the S Fund. Pre-retirement you could probably make twice or three times as much as the L Funds.
The main issue is that you have to really be honest with yourself and really get deep in your psyche and ask yourself one really important question: Can I stand and watch my C Fund drop like a rock at certain times during a 20 or 30 year career and bounce back? This is very, very hard to do. Few people can do this. Your stomach may be sinking but your brain has to say, “Let it ride and let it bounce back.”
The other problem is that when a Super Event or any significant downturn happens, people don’t really know why this is happening and they also don’t know how much further the C Fund could go down. Did anyone really expect a world wide pandemic to show up almost out of nowhere and shut down society? Did anyone really expect the mortgage industry to implode and possibly cause all the major banks to possibly fail in 2008?
It’s easy to say after the fact that you knew everything would be okay but when it is actually happening, nobody is very brave. You almost have to have ice water in your veins to watch the C Fund implode and not flinch. I tried but I could not do it. I was able to keep my money safe and had a decent return but I could not watch the Stock Market crash and sit still.
So the final result from all the analysis I have done during last year’s Covid related Stock Market panic is actually a positive one. The C Fund recovered and did very well for an end of the year return. Also remember, the two months that were really affected were February and March 2020. When we look at the whole year, the results were fine. Another lesson learned but at a painful price.
New idea #2: Now that we have talked about the C and S Funds, here are some other things I’ve learned as well. Another analysis I did was compare what would my TSP look like during post-retirement if I kept my funds in the C Fund for 30 years or put them in an L Fund situation. What would be the end result?
I realized that some previous estimates I had conducted were still valid. The average returns of the Stock Market for the last 100 years has come out to 6% - 7%. If you invested in the L Funds in your TSP and were able to successfully achieve a 6% - 7% return for 30 years, you would end up in the same place as if you had been investing in the C and S Funds! That’s due to the time factor. As more time goes by, the funds rate of return will regress slowly but surely to the mean or average. The activity of all those years going up and down ends up smoothing out to the 6% - 7% average. The more time the fund is active and the higher the balance of the fund gets, the less rate of return is necessary to achieve your target TSP balance.
If you just invested in just the C Fund, then your L Funds would need to average about a 7% - 8% return. Still very possible. We are not talking a year by year comparison because of all the roller coaster returns going from very high to very low each year. We are talking about final numbers after a 20 - 30 year career. It’s just a different approach. By looking at your funds in a 20 - 30 year time period, instead of year by year, you can see how your money grows over time and reaches the same place as the C Funds. It’s a long term approach versus a short term approach. No approach is good or bad, it just depends on your perception and peace of mind. Which approach makes you sleep peacefully at night?
The real issue is can you watch your C Fund move up and down over that time or would you rather smooth out your gains/losses? This is a very personal question. It’s kind of like when you have surgery and the doctor asks you what your pain tolerance is. Some people have a very low pain tolerance and some have a higher pain tolerance. There is no right answer. What you should do is once again ask yourself, what kind of person you are? Can you watch the C Fund go up and down over the years, especially in 2008, or would you rather smooth it out and keep it at 6%, 7% or even 8%? Those are still very good returns and it’s still hard to get even that consistently.
One more thing about the C Fund. I would think the C Fund is pretty safe if Warren Buffet said that when he dies, he was going to leave his whole fortune to his wife in a mix of 10% in a cash or G Fund and 90% C Fund, which out of the TSP is called the S&P 500 Fund. A very aggressive approach but it took Buffett 70 years and plenty of gains and losses to figure out what to do. Not many of us are like Warrant Buffett.
Here’s something else to think about. Warren Buffett also said that if you want to have a successful return in the TSP or other 401k for long-term retirement, you should realistically try to reach a 6% - 7% return over 30 years! (You can find the the article with that information on the internet. It’s not too hard to find.) I came to the same conclusion he did in a different way but he articulated it much better than I did
That means for a simple way to accomplish this with the L Funds is follow the Stair-Step Method I mentioned in a previous blog. For example, put your funds in a 5 year fund like L2025 and when it reaches 2025, move it to the L2030 for 5 years. Then when it reaches 2030, put the funds in the L2035 for 5 years, etc. By doing this you will consistently receive 6% - 7% returns and be in a pretty safe place. If you want to use the 10 year funds like the L2030 during your pre-retirement and switch to the 5 year funds post-retirement, that’s not a bad plan either. It’s just a little more risk during pre-retirement but since you are still making contributions, that should protect you from any Stock Market downturns.
Another approach, if moving the money every 5 years is not your thing, is to put the money in the L Income Fund. There you will get a 5% return and never have to move it again or worry about Stock Market downturns. It will always be safe and 5% will get you to a comfortable retirement as well. This approach would probably apply best for post-retirement people.
My last comments are now mainly for post-retirement people. Many of the issues I’ve talked about were really for pre-retirement people. Some of the same strategies can be the same for post-retirement but not all. It would make your TSP too vulnerable and you could lose money that you would not make back. The main emphasis for post-retired people is to protect the money you have. That’s why in a previous blog I called the first 10 years of your retirement, “The Danger Zone.” If the Stock Market takes a major downturn those first 10 years, it may affect your TSP for the next 20 - 30 years, and prevent you from getting back the money you lost!
If your mainly in the C Fund during post-retirement and the TSP suffers a major Stock Market crash and you start losing 12% -15% or larger of your TSP, the only way to build back up your TSP is to either reduce or completely stop taking out money from the TSP for your retirement for about 5 - 10 years, so it can grow without any deductions. However, if you keep taking money out of your TSP, you will watch your funds completely deplete in about 10 - 12 years. All the funds will be gone. Retired people have to be more careful. You don’t want your retirement to be about you worrying how to get back money you lost during a Stock Market crash.
You can still follow the Stair-Step Method and you would be safe doing that. You could do the L Income Fund Method and still be okay as well. I wouldn’t put all my funds in the C and S Funds post-retirement. There is just not enough protection. You have to spread out the risk. Maybe a 40%, 50% or 60% mix for the C and S Funds. Then keep a majority of your money safe, like in the G Fund. I wouldn’t use the F Fund at this time. If interest rates go up as expected, the F Fund will not do well.
If you want to discuss this further, I am always glad to hear different points of view. There are always new ideas. It took me a while to figure the TSP out and I know it’s hard to reevaluate your assumptions but each year brings in new issues for the TSP. It’s important to always keep your mind open to new ideas, even if you think you have the TSP all figured out.
Good Luck!