Managing TSP on fear usually results in loss

Volatile markets take their toll on many investors’ nerves, including those who are relying on their Thrift Savings Plan accounts to provide them with needed retirement income. When prices fall rapidly, as they have recently, many investors react with fear. The more prices fall, the more fearful investors become. Eventually, if prices fall enough, fear turns to panic. Somewhere along the way, many investors — usually those who have lost the most — give in to their fear and abandon their risky investments.

This is an irrational response to falling prices and often does more harm than good in the long run. Abandoning TSP’s stock funds — the C, S and I funds — because they lose value, and replacing them with the more stable G Fund, for example, reduces the risk of loss in the short run but may well condemn you to failure years from now when your account will not have grown sufficiently to support your needs.

This assumes, of course, that your retirement plan requires the long-term rates of return offered by the riskier funds to meet your lifetime goals, and that the G Fund’s expected rate of return will not likely do the job on its own. If this is not the case, then you should adjust your asset allocation to one that is more conservative — just aggressive enough to support your retirement plan. Regularly rebalancing your account to the most conservative allocation that can be reasonably expected to support your plan means you sell the most risky funds when you can afford to do so — usually after they have risen and before they have fallen substantially.

The problem with managing your TSP account based on emotion is that it usually leads you to focus on short-term comfort at the expense of your long-term interests. Avoiding the risk of short-term loss may soothe your nerves now, while dooming your plan to failure years from now, like a silent time bomb. It might be tempting to try to time your way to lower risk by selling after markets have fallen with the hope of avoiding further losses, and then reinvesting the money in the riskier funds once prices have stabilized. Unfortunately, this is hard to do successfully and can increase risk rather than reduce it. You have to time both exit and re-entry successfully. Failing in either decision can mean missing out on valuable, unrecoverable growth.

One of the realities of investing in volatile assets such as the C, S, I and F funds is that their value for retirement funding lies not only in their value today but in their prospects for producing additional value in the future. As the current value of these funds falls, the prospect for their future value production rises. In other words, the expected rate of return for the C Fund is somewhat higher when the share price falls to $14 per share than it was when the price was $16 per share. At $10 per share, the current value has fallen further, which is bad. But at the same time the prospects for future returns have risen further, which is good. Since the success of your retirement plan depends upon where you are today, financially, and what happens from this point forward, these see-saw characteristics of the TSP’s volatile investment funds can work in your favor if you use them properly.

Keep in mind that the see-saw works both ways: As share prices rise rapidly, the expected rate of return falls.

A prudent investor who begins with an efficient asset allocation — that is, one that produces just enough risk to support retirement goals — should sell the most volatile assets as prices rise, and buy them when prices fall. This is counter to most intuition, and difficult to do when emotions rule your decisions. The best method to avoid serious mistakes in managing your account is to simply rebalance to the appropriate asset allocation in times of stress. This approach is most valuable when your emotions are the strongest and the risk of error the greatest.