As I made my family’s vacation plans for the summer, I was looking forward to a break from work. I’ve set up my business so that it can run on autopilot and I can be contacted in case of an emergency. Because I’ve carefully planned my vacation and work schedule, I know that any problems that do surface will be manageable. I counsel my clients to take the same approach to their Thrift Savings Plan (TSP) accounts.
Retirement is the ultimate vacation. The better you plan for it, the better it will be. If you’re like most people I’ve worked with, you expect your TSP savings to help support your lifestyle in retirement — a reasonable and appropriate demand.
However, some people define their TSP accounts’ role differently. They expect their accounts to produce the maximum possible return over any given year, month, week or even day. Some participants have admitted to me that they monitor their account balances daily. These people have an unreasonable expectation for the future and are needlessly concerned with the past, particularly the recent past.
It’s good to be involved in your retirement planning. But it’s not good to fixate on the short-term numbers. If asked, I suspect that most participants, even those daily account watchers, would have little or no understanding of the risk they are taking. In this case, risk is the possibility that their TSP accounts will fail to deliver the results they expect.
If you’re not relying on your TSP for income to fund your retirement, then you may be able to treat your TSP balance like a stack of chips in a casino and gamble without concern. However, if you are like most of us, that TSP balance will make an important difference in how you’ll live your life for 20, 30 or even 40 years or longer in the future. Your TSP account’s No. 1 goal is to support the highest standard of living possible for as long as you or your spouse, if you have one, are alive.
When you’re young, an active vacation where you water ski or try mountain climbing may be appealing. You’re less worried about the risk of injury and time off from work. The same is true for your TSP retirement savings. When you’re young and have decades to work, earn and invest, taking the additional risk in the quest for higher rates of return is often an appropriate strategy.
Since expected rates of investment return and the risk required to earn those returns are immutably connected, chasing higher rates of return usually involves taking greater risk.
When you are older, your interests change, as should your investment strategy. If you are nearing retirement, or have already retired, your TSP account becomes much more susceptible to risk. In order for your TSP account to achieve its goal of supporting maximum income for life, it must first survive a long as you or your spouse. Before you can worry about potential return, you need to eliminate the possibility that your account will run dry before it’s no longer needed — dipping to zero while you are still alive.
Let’s go back to that vacation trip I was talking about and think of your TSP balance as an airplane in flight. While it is flying relatively high, a temporary loss of altitude because of an unexpected downdraft, may make you queasy, but will not be disastrous. Rather than hitting the ground, the plane will continue flying and, given a little time, recover its lost altitude and land according to schedule.
As you retire and begin withdrawals, your TSP balance, like the plane, begins its descent. As time goes by and withdrawals continue, the plane gets closer to the ground. At some point, the plane gets close enough to the ground that a reasonably large downdraft would cause it to crash. Planes deal with this risk by flying within their limits and avoiding weather that poses unacceptable risk.
TSP investors can avoid the risk of failure by making sure that their investment and withdrawal strategies are coordinated so that as their account balance “descends,” the risk of severe “weather” is managed.
This is really an exercise in balancing withdrawal rate with risk. Your withdrawal rate determines your account’s “rate of descent.” The market’s risk — volatility — is like the weather and produces “downdrafts” that must be planned for.
As your account balance declines, you can tolerate less risk. But, you have to be mindful of being too conservative or you will unnecessarily depress your withdrawal rate. Higher levels of risk, with enough”altitude” will bring greater expected returns and support higher withdrawal rate.
The trick is to find — through retirement planning — the optimal, or nearly optimal, combination of withdrawal rate and risk.
As you plan your summer travel, leave concerns over your TSP balance behind. Manage your accounts in a way that is appropriate to your level of risk and you’ll be able to take the trip of a lifetime at retirement.
Written by Mike Miles
For the Federal Times
Publication August 7, 2006