Your Thrift Savings Plan investment strategy should support your specific goals.
Unfortunately, most of the unsolicited advice offered in the popular media, and even by many financial
advisers, fails to consider an investor’s unique goals. It is designed to sell products and services — usually by promising high potential returns without regard to the risk involved in seeking those returns. The problem with this type of advice is that it often runs contrary to the investor’s objectives.
Blindly seeking maximum possible rewards from an investment, without considering the risk involved, can sabotage your plans for a comfortable and secure retirement. Understanding the importance of risk in managing your investments is critical to success.
Ideally, your TSP account’s value starts low and then climbs during your working years — the
accumulation period — to its peak value. Then, when you retire and begin taking withdrawals, the value
begins to fall and continues to fall until the end of your life, or the life of your surviving dependent, if late
During the accumulation period, the primary investment risk is that the value your account achieves at its peak — at the time you retire — is less than what it could have been, or, more important, less than what you expect it to be. Your account’s value as you enter retirement will determine the amount you can
expect to withdraw from the account each year as income. The higher the value, the larger the withdrawal that the account will support.
During the withdrawal period, the primary risk is that the account’s value will dip severely while one or
more dependents are still alive. This is a catastrophic management failure and, for many participants, the worst possible outcome.
A subtle aspect of investment management that eludes many investors is the fact that risk and return are
not symmetrically opposed to one another. Downside risk, since it can lead to catastrophic failure, should be of greater concern than potential upside reward.
For a TSP participant whose lifestyle in retirement depends on his account’s ability to support the largest
possible stream of income, increasing income by taking larger withdrawals from the account increases the risk of running out of money too soon. Being overprotective to avoid running out of money increases the risk of unnecessarily sacrificing lifestyle and leaving a larger-than-necessary account balance at the end.
A good investment strategy, then, is one that will provide the maximum expected rate of return without
subjecting the participant to a significant risk of failure. This strategy starts with risk and follows with
return, not the reverse. It is impossible to give relevant, effective advice, or select a suitable investment
strategy without first knowing how much risk can be tolerated. Since risk and return are connected —
expected rates of return generally increasing with risk — an investor’s risk tolerance should be determined by the circumstances, not the investor’s sensitivity. The right investment strategy should contain enough risk — and expected return — to achieve the investor’s goals, and no more. Risk should only be increased until it is just a little less than that which will produce an unacceptable probability of failure.
A good professional adviser will first understand your circumstances and goals, then determine the
amount of risk that can be tolerated in seeking to support these goals, and finally, develop an investment
strategy that will maximize the expected return for this level of risk.
Fortunately, for those without the means or desire to conduct such a complex analysis, TSP can do much of the work for you. The L Fund allocations offer a series of investment strategies, or asset allocation models, that have been professionally designed to produce the maximum expected rate of return available at a variety of risk levels. The tricky part is selecting the right withdrawal rate and L Fund
Written by Mike Miles
For the Federal Times
Publication May 15, 2006