PODCAST EPISODE 138: Your Mindset on TSP in a Down Market

Have you had a recent gut check as you’ve seen your TSP account take a tumble? If so, you might be wondering what to do next, so this episode is for you.

Hi, Chris Kowalik of ProFeds here and welcome to the FedImpact Podcast where we offer candid insights on your federal retirement. You guys know this show is all about helping you to get clear on what you want retirement to look like and taking action to make it happen. So, many long-time investors in the TSP have been up in arms about the market’s latest downturn and so many people are questioning what to do now after they’ve lost five or even six figures in the TSP. Should you ride it out? Should you bail and maybe try to figure out what got you into this mess in the first place? What put you in a position that you had the ability to lose so much money in the TSP? I’m not necessarily saying you’re in a bad position, I’m saying we have to understand the mechanics behind why these things happen and what to do about it.

I want to be fair about this conversation and in order to do so, we have to address a couple of things. The first is that we have to understand that there are different stages that you might find yourself in the investment cycle. We’ll take a look at different types of people at different stages in their life and how their reaction to a down market might be very different than one another. The next is we have to understand risk tolerance and we’re going to talk a little bit about the financial capacity to lose money, which is how much money your portfolio can lose and you’re still okay, but we’re also going to talk about the gut reaction that you have and that is the more visceral feeling that you have when you see the market tank and what it does to your stomach. We want to make sure that we understand both sides of risk tolerance and give each their due.

Then next we want to talk about how aligned your investment choices are with your risk tolerance. It’s great to do your risk tolerance kind of assessment and figure out where you are on the spectrum, but if your investment choices aren’t aligned with you, then you’re probably going to feel amped up during times of market volatility instead of feeling at peace with what you’re doing. So of course, like I always do, any resources that we mentioned today will be in the show notes and for anyone looking for training or more help on their individual situation, we’ll tell you how to do that at the end.

So let’s kind of jump into a little bit of a background. It’s no surprise to any of our listeners that the market goes up and the market goes down, whether it’s the TSP or any other type of investment that’s out there. But what we want to do is to give a little bit of perspective to some of those feelings or some of those reactions that you may have about the value of your current account in the TSP and what to do if that sticker shock scares you, that when you open it up and you look at your account balance, what it’s doing to your gut and what it’s doing to your heart. If your heart is racing, if you feel like you want to throw up, that’s probably a good sign that maybe things are a little nuts for you. We’re going to talk really about that, but from a background standpoint, we of course recognize that markets go up, markets go down, no surprise to anybody here.

Let’s talk about the distinct groups of people. We have to categorize people and I don’t want to oversimplify this, but I think it’s important to realize that at different stages, people feel differently about different market conditions. So the first group of people are those people needing money from the TSP now. Next are those people needing the money from the TSP within the next five years. The last category are those people needing money from the TSP more than five years away. And again, I don’t want to oversimplify things, but I do want to give some boundaries to the discussions that we’re having on the different types of investors that we have based on their timeline.

Your reaction to losing money in the TSP will largely be determined by which group you’re in and it should be different for each group. Someone who’s a long ways away from retirement has time to recover, they’re not taking money out right now, they’re going to continue to invest all of those good things. But someone who needs the money right now is relying on that money to be there at a value that’s high enough that it makes sense to take the money out. So it’s not a big shock to anybody I think to hear these different categories of people, but everyone’s going to react a little bit differently based on the category that they’re in.

Let’s think about an investment objective. I think we all know the adage that we’re supposed to buy low and sell high. Buy low, sell high. You buy when the value of the share is relatively low and you want to sell it when the value of that share is higher than where you bought it, because that’s where you make the money.

The problem is we don’t know when that is, we don’t know when the low is, we don’t know when the high is. But when we space out our investments systematically, like you guys do every two weeks that you’re contributing, you’re doing what we call Dollar Cost Averaging. It’s the idea that when money is going into an account that you’re spreading it out over a long period of time, and in your case, every two weeks you are investing the same amount every time, regardless if the market’s up or the market’s down.So when the market’s up, even though we might feel good when the market’s up, we’re actually buying fewer shares because we only have so much money that you’re investing each pay period. But when the market is down, when we’re kind of in the dumps about the market, we actually get to buy more shares down there because they’re cheaper.

But Dollar Cost Averaging doesn’t just work on the way in it works on the way out too. So the idea that when you go to take your money out of the TSP that you don’t have to take it in one big chunk and hope that you timed the market right, but that you can take it out periodically to spread out some of the risk of it being a bad time to take the money, and this works whether it’s in the TSP or in an IRA or any type of account like this. Dollar Cost Averaging is a cool phenomenon that we have in the financial planning world that helps investors to get a leg up in the market when they’re nice and disciplined about investing, which federal employees if there’s anything you are, it’s committed and determined when it comes to investing that you’re going to stay on the course day in and day out, pay period in and pay period out to make sure that that money gets in the TSP.

I want to talk about something that I think infuriates some people when they hear it because they don’t really understand what it means, and that is when someone tells you, “You just have a paper loss.” And for those of us who understand how this works, it makes perfect sense, but for someone who doesn’t, I can see where it can be frustrating to hear something like that because you’re like, “What do you mean? I’m looking right at my statement and I legitimately lost a lot of money.” And that’s true, you have lost the money that you’re seen reflected on your statement. The value of your account is lower than what you believe it should be based on how much you’ve contributed and the gains that you’ve had over the years and so you’re seeing that money out of your account, so it doesn’t feel like a paper loss to you. So what does that really mean?

The term “paper loss” means that on paper it looks as though you’ve lost a lot of money as far as the account value, but we have to look at the number of shares that you have. Every time you’re investing in the TSP, you’re gobbling up more and more and more shares to put in your bucket and the value of those shares determines your account value, the statement balance that you’re seeing on your account. What we always want to be looking at is do we have more shares in this statement than we did in the last statement? And naturally, the more you continue to invest, the more shares you accumulate. Regardless of the value of those shares, the number of shares either remains the same, meaning you didn’t buy any additional shares, you weren’t investing during that period, or the number of your shares went up because you continued to invest.

The idea with a paper loss is that the value of those shares is simply lower than your previous statement (if we’re going to kind of look at a timeline like that) and as long as you’re not taking money out, that’s okay, you haven’t realized the loss yet because you haven’t sold the shares at a low value. So the paper loss, it can still sting, it doesn’t feel good when your account value has gone down, but you have the capacity as an investor as long as you don’t need the money right now to allow those share values to recover so that your account value goes up. The better those shares do, the more value each of them carry and so that’s when we’ll see your balance going up in the TSP, aside from the additional money that you’re putting in, of course.

Now some people don’t even open their statements in a down market. This is a total coping mechanism and hey, listen, as long as you’re not taking money out of the TSP, that’s okay. You can put the blinders on and sit tight and if that’s what you need to do to kind of get through a little bit of a rough patch in the market, again, assuming you’re not taking money out of the TSP and you’re not within that five year window of needing money, then you’ve got a long road ahead of you and you can put those blinders on pretty safely and kind of the “buy and hold” mentality that many of you have heard of. And I know there are lots of different philosophies out there for investing, but the idea that we have time for a market to recover I think is an important aspect of the conversation.

Next up we’re going to talk about risk tolerance. So like I mentioned before, there are two different parts of risk tolerance. The first is the financial capacity to lose money and that essentially is how much money you can lose and still be all right. So you might have tons of money and so losing a little bit of it, no big deal. And tons of money is relative for everybody so I’ll let you figure out what tons of money feels like to you. But the other part, and the part that tends to get investors in trouble, is their gut reaction. That how big does the loss need to be before you want to throw up? That is the very best way that I could describe the gut reaction part of risk tolerance and many people… that margin is very small. That amount that they lose before they really feel it in their gut is not all that much and so they’re pretty conservative investors.

Whereas some of you are on the other end of the spectrum, not many of you, but some of you, that are like, “Let it ride. Let’s go, let’s go get it.” And your gut isn’t warning you about anything, which is okay ,as long as you’ve got time, time ahead of you and you are not putting yourself in financial jeopardy by losing money because you can be okay losing a lot of money when financially speaking, you do not have the capacity to lose money and still be okay. Most of the time, people’s financial capacity to lose money and their gut reaction to losing money are more aligned. That we don’t have somebody who’s on one end of the spectrum for financial capacity to lose, whereas they’re on the other end of the spectrum for gut reaction. There’s normally a reason why your gut is telling you that you need to be on one side or the other.

A lot of the hesitation or the reaction that we get in the market’s downturn is this idea of time to recoup your money. When we look at recovering your losses, we have to remember to look at the share prices, not the account values. Again, when we’re looking at recovering your losses, meaning how do you get back to whole, you have to look at the value of the shares, the actual share price, and when it recovers back to where it was before it went down. That’s how we measure recovering a loss. We can’t look at account values because you’re continuing to contribute to the TSP, you continue to get a match and so that’s going to skew your perception of how quickly you recover from a market loss. I want to give a little perspective here. So, many of you have been with the government for several decades, let’s rewind back to 2000, so this is the dot com burst. We’re going to look at the C fund because frankly, the S and the I fund didn’t exist back then.

If we look at the C fund in 2000, it went down by 9% the next year down by 11% and the next year down by 22%. When we look at the value of those shares going down and down and down, how do we know when we’ve recovered? Well, it took eight years for the share values to recover in the C fund to get back up to the level that they were before the loss in 2000. So from 2000 to 2008, it took all of that time just to get back even. And listen, if you didn’t need the money during that time, no big deal. You’re buying shares when they’re really low, they’re on sale and it felt great because once those share values rose, then it was beautiful. Your account value blossomed, and we all loved it, as long as we didn’t need the money. But if you needed the money during this time, you were forced to sell shares when the value was very low, meaning you had to sell a lot of shares to get the money out that you needed to be able to live your life in retirement. That’s the scary part of all of this.

So here we are, 2000 dot com burst, it takes a couple of years to really hit bottom and it takes eight years to recover. So here we are in 2008. Anybody remember what happened in 2008? Yeah of course, we had the market crash again. Investors saw huge losses in investments across the board. Of course, not just the TSP, but everywhere we saw it. If we’re just going to focus on the TSP, just as an example here to give some perspective, the C fund lost 37%, the S fund, of course, was around by this point it lost 38%, and the I fund lost 42% in 2008. I just want to focus kind of on the C fund as an example, because of course that’s large market US stocks, our big companies, our largest 500 companies that are publicly traded in the US stock market, and so it’s a pretty good indicator of what’s really happening in the country.

With the C fund in 2009, there was a 26% increase, or a 26% rate of return. In 2010, there was a 15% return. So if it lost 37% in 2008 and in the next two years it looks like there’s a combined 41% gain, didn’t we make up the loss right then? Well, the answer is no, because that’s not how investment math works. It actually took six years for share values to recover. To make a point, we’ll just use some easy math here that everyone can kind of play along with. If you have $100 and you lose 20% of it, you have $80, I think we can all agree on that math, but what rate of return do you need to get that $80 back up to $100? If you said 20%, you’re wrong. It’s 25%. You can do the math. If you take $80 times 125%, you’re going to get back to 100. But to crawl out of a loss, it takes a much bigger gain to get back to normal.

Don’t let this idea of seeing rates of return and just adding them up and thinking that that’s how it’s going to work, that’s not how it works at all when it comes to investment math. When we’ve had a loss, it takes that much more effort to get out of the hole, so to speak, and get back to normal.

But if you wig out now, if you are freaking out about your account, maybe you’ve lost those five or six figures in TSP, I’m going to let you in on a little secret that most people don’t want to tell you because it doesn’t sound very nice and that is, if you’re freaking out, chances are you were not properly invested with your true risk tolerance. And I say that out of an abundance of love because I want to make sure that you can appreciate that your risk tolerance, that financial capacity to lose money and still be all right, and your gut reaction to money matters. And you need to make sure that you are aligned with that with the investment choices that you’ve made.

If not, you’re going to likely make some financial decisions that you are going to regret that you can’t take back. You’re going to freak out, you’re going to sell… you’re going to run for the hills to the G fund because that’s where you think safety is and meanwhile, you no longer have a paper loss, you no longer just have shares that are undervalued, now you now have a real loss because you have sold those shares to move to a different investment platform like the G Fund. You’ve got to be really, really careful about not being aligned with your risk tolerance and then making bad decisions because of it.

All of this has to do with perspective, and many of you have heard me talk about perspective before, what you see depends on where you sit. And so those people who are really far from retirement, they’re like,” What’s the big deal? The market went down a little bit,” but for those people needing money right now, you’re like, “Oh my God, where did my money go?”

So while you’re working and not pulling money out, a paper loss is really manageable. But once you need the money, that huge market loss, and huge is relative to everybody, whatever huge feels like to you, that means you have a real loss because you’re having to sell shares when the value is low, just like we saw in our previous example. What happens, especially at the beginning of retirement when we’re forced to take money out of an account because we need it to live and the market is down, we have to sell way more shares than we should because they’re undervalued and that can spiral an account down quickly, way faster than an investment professional would suggest you do. It ultimately means that you have a greater risk of running out of money because we had to take money early in your retirement from a down market. There’s a lot that goes into this!

Some other factors as far as your perspective, your age, how soon you’re going to need the money and here’s another one that I think a lot of people don’t think about, other assets and the percentage of your loss compared to the total amount of money that you have. That’s all going to play a factor. If the loss that you had was in one account, but you have four others that are performing well, who cares, right? I mean, I won’t say who cares because of course we all care, but the idea that there’s lots of different levers that you’re able to pull in retirement because you’ve got these different buckets that will probably feel really good. But if the TSP is the only investment account that you have and you just lost six figures in it and you’re about ready to retire or already retired and starting to need the money, you have a very big problem, very big problem.

If you didn’t listen to the podcast that we had on playing offense and defense with your retirement decisions, very, very important you go back and listen to that. We’ll link to it in the show notes so that you have that. But this idea that at different stages in your investment life, you have the ability to have different assets that play offense and defense for you. And it will feel different while you’re working versus when you’re already retired, and it should feel different. You have different perspectives there and both of those need to be managed properly. It doesn’t do us any favors that we’re in this high inflation, like record high inflation period, so the loss feels even worse because not only do you not see your TSP account value high, you’re like, “God, it takes so much to buy groceries and gas.” So it can really feel like a big weight on your shoulders if you’re in this situation and feeling that loss a little bit more profoundly than other people do.

All of this that I’ve shared with you highlights the number one problem with the TSP in retirement. I try to share this anytime I can because it is such a glaring problem with the TSP that most people don’t want to admit, and that is that when you go to take money out of the TSP, you are not allowed to pick and choose which fund to take the money from. So if the C fund just took a big nose dive and you need money, you are not allowed to take the money from just the G Fund, for instance. Because the G fund didn’t lose any money, we know that that’s how that works. We also know the G fund doesn’t keep up with inflation. But the idea here is that if you had a bunch of your money in the C fund and the value just tanked from a math standpoint, we don’t want to sell the shares when they’re in the toilet, we want to allow them to recover before we take them out.

And so naturally, if we could, we would say, “Okay, let’s leave those shares alone, let them get better and let’s go ahead and take the money out of the G fund that has suffered no loss.” But the TSP does not allow you to do that. You have to take your money out proportionally to how it is invested. Now, if you had your money in the private sector, you’re going to have different buckets of money that you’re able to pull individually. You’re going to have maybe your S&P fund that’s performing like the C fund, you’re going to have a safer fund that has a rate of return on it like the G fund. You have all these different buckets that you can take the money from based on different market conditions. Because the reality is that TSP is a great wealth accumulation fund, it’s pretty simple to invest in TSP, you get a great match, the fees are relatively low, not quite as low as you can find out in the private sector, but pretty low given what you’re doing.

So it’s a great way to accumulate wealth. It’s not a great way to distribute wealth – meaning when you need to take the money out to live on the restrictions that the TSP puts on you being able to pick and choose which bucket of money you take it from is significant, and I’m not going to understate that here. I’m going to say it loud and clear. Wealth accumulation versus wealth distribution is very, very different in the TSP. So you need to be very cautious leaving your money in the TSP because once we start to see any mark volatility one way or the other, you need to know that you are going to be bound by how your investments are currently in the TSP. Any money you take out has to be taken proportionally to those percentages. Think very carefully about leaving money in TSP when you’re in that wealth distribution phase.

What do you do next? Well, I’ll tell you what not to do. And that is don’t stop investing during a down market. You know we’re supposed to buy low and sell high. It just doesn’t feel very good sometimes. But remember the idea of Dollar Cost Averaging that regardless of what the market is doing, we’re going to put the same amount of money (in your case every pay period) that goes to the TSP and you’re spreading out some of the risk of investing at the wrong time in the market. That’s the simplest way I can describe Dollar Cost Averaging. Certainly on a podcast it’s a little bit more difficult cause I don’t have any charts or anything to be able to share with you. I also want to share with you another thing not to do and that is don’t make knee-jerk investment decisions. Please don’t run to the G fund without consulting a financial professional first.

Doing things like this can be very dangerous and we want to be looking at the whole financial picture that you have with a licensed professional that can look at this from a different lens than you can so that they can help you gain a little perspective and look at what you’re ultimately doing. Really from an investment standpoint, there are kind of two philosophies and they vary based on the timeline that you are on, if you need the money right now, if you’ve got a long time until you need the money. The first is, and I mentioned it a few minutes ago, and that is the “buy and hold” strategy and that is you’re going to buy the shares and you’re going to hold onto them and wait for them to recover. And that’s not necessarily a bad strategy and many hold that strategy for a long period of time in their life.

But the other side is if you need the money, the idea of selling now. And it might seem a little bit counterintuitive, but the reality is we don’t know when the bottom of the market is. We don’t know where the top is either. But do we ride the market all the way to the bottom or do you cut your losses? And I don’t know the answer to that question for you and what the right thing to do is because I don’t know your financial situation, but it’s worth for you to find out. And the very best way to do that is talk with a financial professional that understands the TSP and some of the complexities that you have in this account so that you can gain some perspective on what you’re doing. So you’ve got to get clear on your risk tolerance and figure out are your investment choices in the TSP aligned or not? So if you say you’re super conservative, but you have 30% of your account in the C fund, something’s off, right? I mean, we’d have to agree that that doesn’t seem aligned.

Now, I’m not going to suggest that you should have all of your money in the G fund, that’s kind of going broke safely because the G fund doesn’t keep pace with inflation, you will run out of money, great likelihood that you run out of money if all of your money’s in the G fund and you have nothing growing to account for losses that happen. And so we want to make sure that you have income that you need in retirement. So I can’t tell you what funds you should be invested in, but I do want to warn you about making some really bad decisions at really bad times. And these are decisions that you can’t take back. When you punt out of a particular investment and you go ahead and sell, you are locking in wherever you’re at, either a gain or a loss, in this case we’re talking about losses. But so many investors leave a market situation like this with tons of regret. They realized they reacted poorly and they wished they could do it over.

Do yourself a favor, before you make any big decisions in the TSP, please consult a financial professional. We’re happy to make an introduction. We have advisors all over the country that we’re partnered with that understand the federal space, they understand the complexities within the TSP and frankly all of the other benefits that you have as well. So the best way to do that is to come to one of our workshops. If you feel like you have something so time-sensitive that you need to talk to somebody right away, we will be happy to make that introduction directly to the financial professional. If you feel like you’ve got a little bit of time and you still want to talk to somebody, but you want to kind of get your ducks in a row first and understand what you’re up against in the retirement planning game, get to one of our workshops. We want to make this really easy for you.

So since obviously we’re in an audio format here with a podcast, the best way for you to get all of this information really easily is to pull out your phone and text the word PODCAST to 224-444-6144 and we will make sure that you not only get today’s show notes with the transcript and the links to some of the other podcasts that we’ve mentioned, but you’ll also see all of the open workshops and the ability to request help directly from a financial professional in our network. Again, to get that text the word PODCAST to 224-444-6144 and we will send that right away. Now remember, you’re going to have an opportunity for some one-on-one help following our training and you’ll be able to get that through this podcast link as well.

Just remember, investing is not for the faint of heart. It is a rollercoaster ride, if we’re lucky, because the market’s going up and the market’s going down is what makes it work. keep in mind that even in times of market volatility, there’s still a tremendous amount of opportunity and gaining that perspective, making sure that your investments are aligned with your risk tolerance and knowing what category of people you are, of are you needing the money right now, are you going to need it here in the next five years or do you have a much longer timeline to go before you need the money is really going to determine a lot of the strategy that you’re likely going to use in the TSP.

I hope our talk about your mindset in the TSP in a down market has been helpful to you as you think through all of the various aspects of planning to retire. I also hope that you’ll stay tuned to the FedImpact Podcast to get straight answers and candid insights on your federal retirement. And of course, if you haven’t already, please subscribe today so you’re sure not to miss an episode. We’ll see you next time.