While there is no perfect investment allocation for your Thrift Savings Plan account, the distribution of
your account balance among the available investment funds can be adjusted as time goes by to better
meet your needs. Your first goal should be trying to avoid any major mistakes. Then you need to be
aggressive enough to support your retirement time horizon and make sure you’ll have the cash you need.

The TSP’s proposed L Fund should provide a convenient answer to many of the questions participants
have about allocating their account investments. It is being designed to shift your investment allocations
gradually, according to how soon you expect to need to withdraw the money. Direct your TSP assets into
the fund and let an unbiased professional take the reins. My only concern about the L Fund is that I find
the shorter-term allocations to be more conservative than I might typically recommend.

Following is a rough outline of the approach that has produced optimal results, on a prospective basis,
most frequently in my experience:

  • 20 years before retirement: Invest heavily in the stock market to take advantage of its high expected growth rate. With this much time on your side, the rising tide over the years will likely overwhelm even the largest short-term downslides. I suggest an allocation in the TSP’s three stock funds, consisting of about 60 percent in the C Fund, 30 percent in the S Fund and 10 percent in the I Fund.
  • 10 years before retirement: Think about beginning to shift some assets into TSP’s less volatile fixed-income funds, specifically TSP’s bond market fund. While 10 years is a long time, you don’t want a serious bear market to undo what has been accomplished in the preceding 10 years without adequate time to recover before retirement. I suggest moving to an allocation of 55 percent in the C Fund, 26 percent in the S Fund, 9 percent in the I Fund and 10 percent in the F Fund. Gradually, perhaps yearly, you should migrate your portfolio toward the next target allocation, below.
  • Two to three years before retirement: Start moving enough money into TSP’s other fixed-income fund — the G Fund, invested in guaranteed government securities — to ensure that you’ll have sufficient funds available to withdraw. I suggest you keep at least one year’s worth of withdrawals in the G Fund beginning two or three years in advance. So, if you’re planning to withdraw 3 percent of your account balance during the first year of retirement, you should move your allocation to 3 percent G Fund, with the remainder of your balance continuing in a fairly moderately aggressive allocation. Overall, the allocation might look something like 55 percent in the C Fund, 20 percent in the S Fund, 5 percent in the I Fund, 17 percent in the F Fund and 3 percent in the G Fund.
  • During retirement: Continue this migrating approach until your allocation reaches a balanced distribution between stocks and bonds. Reserve one year’s worth of expected cash needs a couple of years in advance and commit the rest to 60 percent in stocks and 40 percent in fixed-income assets.

An example would be 40 percent in the C Fund, 15 percent in the S Fund, 5 percent in the I Fund, 37
percent in the F Fund and 3 percent in the G Fund. This should support a withdrawal rate of 3 percent of
your starting balance per year, adjusted for inflation, over a period of 30 years or more.

Higher withdrawal rates will require a more aggressive allocation and will increase the likelihood of
running out of money before you run out of retirement. Lower withdrawal rates will lower your risk. But
don’t be too cautious — weighting your allocation too heavily toward fixed-income assets like the G and F
funds — if your retirement is 20 years or more years away.

It’s important to keep in mind that investment management is much less forgiving once withdrawals begin. While the money is in the account, the year-to-year fluctuations don’t matter. No matter what the
sequence of annual returns over the years, the ending value will be the reflection of the average rate of
return.

Once withdrawals begin, however, the sequence of year-to-year returns can have a tremendous impact. It can mean going from having money to spare in the end to running out of money in the 10th year, for
example. This is because taking a withdrawal in a particularly good or bad year early in the sequence changes the trajectory of the portfolio from that point forward.

A good retirement investment strategy will have been stress-tested against this sort of bad luck in advance. Remember, there are no guarantees. Regular reviews of your situation and ongoing corrections to your course are your best defense against unpleasant surprises.

Written by Mike Miles
For the Federal Times
Publication June 20, 2005