Are you afraid of losing money? Terrified that if you put your Thrift Savings Plan contributions into anything but the G Fund, you’ll do it at the wrong time and suffer huge losses? I’ve even heard TSP investors express fears about investing in the G Fund.

While it’s certainly better to make money than it is to lose it, the fears that seem to be running rampant lately are often irrational – and might wind up costing you your lifestyle in retirement.

I clearly remember the optimism that reigned over the investment world during the late 1990s. Investors were scrambling to stuff every nickel they could find into the riskiest securities they could find. Based on their rear-view analysis of the previous 15 years of market history, they believed that more risk equaled more reward. The result: flimsy retirement plans that were crushed when the house of cards they relied upon came crashing down.

I don’t think that it was purely chance that the rise of the self-directed retirement plan coincided with one of the greatest, and most irrational, bull markets in American history. Turning over the reins of pension fund management to investors who were unprepared for the job was a key ingredient in the stew we’ve been cooking for the past 20 years. Those heady years of endlessly rising stock markets were just one part of the problem.

So, irrational investors inflated the markets to ridiculous proportions and built their plans on an unsustainable history – incorrectly basing their expectations for the future on their observations from the recent past. Then the bubble burst and those plans had to be scrapped.

Since then, investors have repeated the cycle a couple of times, once in real estate and then in energy and other commodities. But these bubbles came and went much faster. Since the late ’90s, the stock market has looked like a roller coaster going nowhere: trading up and down within a wide range – down 50 percent, up 100 percent – but not really trending up or down during the period. It’s been a mercilessly wild ride that has lasted more than 10 years with no end in sight.

It will end, however, and the odds strongly favor that growth in asset and TSP account values will resume. So, it’s disturbing to me that what was once fearless enthusiasm for risk has turned into an irrational fear of ANY loss of value.

Unfortunately, this bias against taking any risk is actually risky behavior. Avoiding short-term market risk is nothing more than trading one kind of risk for another. Putting all of your money in the G Fund, for example, avoids the risk that your account may lose value over the coming month or year, but it aggressively accepts the risk that your account will fail to fulfill your needs over the long run. Many investors, it seems, prefer to risk losing the war than to risk losing a single battle.

The view in the rear-view mirror, at least where the C, S and I Funds are concerned, is scary. Looking back over the past 10 years, investors see only a series of terrifying drops without any clear rewards.

Well, driving using only the rear-view mirror is foolish. Investing isn’t about what’s happened as much as it is about what is going to happen.

Market volatility isn’t the only, and often not even the most important, risk that you face as an investor. The risk of failing to earn needed returns over the long run is the most important risk to most.

A properly diversified and managed account consisting of all five of the TSP’s basic five funds has handily beaten an all-stock portfolio over the past 10 years. This is something that a rational pension fund manager would keep in mind.

Written by Mike Miles
For the Federal Times
Publication September 13, 2010