According to financial advisors, the number one rule of retirement distribution planning is to plan your income withdrawals to come from the least volatile fund. No one wants to take money out of a declining fund. This is called the Sequence of Returns risk.
From this example, we know that the stock market has dropped about 30% in the last month, and if you are planning to withdraw monthly, you need to remove 30% more from the C Fund to balance your income. It may not look like a big deal, but it is a HUGE one.
When you are withdrawing money from your investment, that means you are selling shares. When your investment drops in value all of a sudden, you need to balance your annual income and sell more shares to finish the task that you started before the value of the stock dropped.
Does this mean this situation is damaging? Does it matter when we know the market will eventually go back up?
Unfortunately, it does matter a lot. When you withdraw your investment and recover eventually, you’re left with fewer shares than you had before and have fewer shares to add on. If this is seen a few times in the first ten years of retirement, you may cut your retirement years.
Let’s study a Case
Let’s see how it works: we will compare two Federal retirees, Mr. Smith, and Ms. Jones.
Mr. Smith and Ms. Jones started with $100,000 investment money. The only difference is Mr. Smith retired ten years before Ms. Jones.
Both made investments in a mix of stocks and bonds, took 5% per year initially, and then increased the withdrawal percentage each year to stay safe in inflation. The 10-year retirement difference had a significant impact on their returns.
Mr. Smith saw negative returns in four of the first ten years and increased inflation rates. Though his Rate of Return (ROR) was higher, the compound of lower yields and high inflation caused the exhaustion of his Plan after just 15 years.
Ms. Jones, on the other hand, saw negative returns in two of the first ten years. She had to deal with the higher inflation, but the timely positive performance of the market helped grow her assets in the early years, and a bull market helped her continue to grow as she withdraws income from the Plan.
The main difference between these two retirement cases was. Unfortunately, Mr. Smith retired at the wrong time.
This data is based on two 31-year periods that ended on December 31, 1998, and 2008. Each portfolio had a first-year 5% withdrawal that was eventually adjusted for inflation. Each portfolio assumed a 60% stock/40% bond allocation that was rebalanced on an annual basis. Stocks are represented by the Standard & Poor’s 500 Index.
How can we resolve this problem?
The best solution for this situation is to invest less energetically. Most people think that it is good to reduce the risk in a portfolio during retirement to reduce the worry about market losses. The best thing is to invest in the G Fund or the L-Income Fund.
Safe investment options might resolve this issue, but it may bring you closer to a bigger problem: inflation.
Over some time, you will observe the erosion of purchasing power due to inflation can be just as bad for a portfolio. If you invest conservatively, you will go out of money, maybe sometime later in life. An increase always affects your income in one or the other way. This chart proves that inflation impacts everyone over time.
The Dilemma of a Federal Retiree
If dealing with inflation is the problem, then a federal retiree should invest more in growth. Right? But if they spend more on growth, they might get “unlucky” and unintentionally get exposed to the market risk. A Big thanks to the ongoing Coronavirus.
Both of these solutions don’t sound good. So, what should be done?
Time Segmented Investment Strategy is the key.
Instead of choosing either “go for broke” or “play it safe,” try your luck on both! But make sure you do it and have some purpose.
It is essential to categorize your portfolios, create a specific Time Segmented investment strategy, and then segregate the money out of their accounts when the right time to do so has come.
It is generally seen that Conservative accounts need to take more money early on in retirement. In contrast, the more aggressive accounts have the time to grow despite ups and downs without any money withdrawal until much later. As the year goes on, you can transfer your money from more aggressive accounts into the safer accounts according to your planned strategy,
Do you think you can apply this strategy within the TSP? No, you can’t. The TSP has already done many things with the new provisions but left this issue.
After the coronavirus lockdown is over and the stock market return back to normal, think about withdrawing some funds from your Thrift Saving Plan and move them to an IRA and customize your strategy for withdrawal.
Yeah, you heard it right.
You might be giving reactions like “Whoa—I never thought it could be sales pitch!” Well, I must mention here that it is not. There are so many low cost, high-quality investment options available in the market that can help you customize your retirement distribution strategy to deal with the unexpected financial crises and inflation risk. So many brokerage houses change zero or near-zero fees and no-commission for transactions. Those can be the best options if you don’t want to look for a financial advisor.
If you want to get something useful from this article, then that is: Don’t let your blind faith in the TSP to lose your money just because they have a problem in their system. Hopefully, the ongoing financial crises will force the TSP to have a look at their distribution rules, but you should do something until they do it for you.
