Historical investment returns seem to be the focus of most investors’ attention. What rate of return did the C Fund produce over the past month? The past year? The past five or 10 years? Visit any investment product website, and this is pretty much all you find. Historical data sliced, diced and cooked up in just about every way imaginable. And, the Thrift Savings Plan’s website is no exception. It is filled with an impressive assortment of historical performance data for the various investment funds it offers. Unfortunately, and most critically, there is nothing about the prospective — or expected — performance of the investment funds to be found.
This is a serious problem for participants who are saddled with the responsibility of managing their accounts to produce a reliable and adequate stream of income during their retirement. Why? Because it is impossible to accomplish this task without knowing what to expect from the funds and, in turn, the entire account. If you use the retirement income calculator provided by the TSP, you’re obligated to enter a return number and then the calculator assumes that your TSP account will enjoy that return each and every future year, like clockwork. Of course, this is a ridiculous assumption and one that, on its own, should relegate the calculator to the trash bin. Even if we are willing to ignore this fatal flaw in the assumptions, how are you supposed to predict even the average rate of return for your TSP account? The best you can do is to estimate the probabilities of various returns, and that requires specialized expertise and a fair amount of effort. Without reliable estimates, all you can do is guess.
To predict the income-supporting capabilities of your TSP account, you must not only know the expected returns for your account over the coming years, but you must also know the range of returns it could produce and the probabilities across this range. If you figure out that the most likely return for the C Fund in a given year, for example, is 11 percent, you must also recognize that there is a slim chance that it will actually produce this return in a particular year. You also need to predict the worst possible outcome and then estimate the probabilities of the returns between the expected return and that worst case. If all of this sounds difficult, it is. But developing the best possible estimates for your account’s future behavior, and using these estimates to guide your withdrawal and investment management decisions along the way is the only way to safely maximize the standard of living your account will support.
The problems with the TSP’s calculator are merely symptoms of a larger problem. Pension fund management is beyond the current capability of the vast majority of TSP investors. With the growing dependence upon self-managed resources for producing retirement income among federal retirees and the prospect for continuing this trend, it’s time for TSP participants, their employer and their Thrift Savings Plan to stop pretending that investment management is something anyone can and should be prepared to do effectively. When the government moved from the CSRS to the FERS, it shifted the burden of funding a significant part of your retirement standard of living from it to you.
Effective investment management is a complex and difficult exercise, usually with life-altering outcomes. It’s not something to be taken lightly. In fact, if you can’t do it right, you probably shouldn’t do it at all. Without the necessary management capabilities, the safest thing to do is to park your savings in the G Fund until you retire and then either leave it there, or use your money to buy an immediate annuity that will guarantee your income for life. This is the dirty little secret that everyone seems all too willing to keep. Neither Wall Street, nor your employer, has any interest in letting the truth slip out. You may leave a large chunk of your retirement standard of living on the table, by doing this, but at least you’ll be secure in the knowledge of exactly how much you’ll have to live on each year. The alternative is to naïvely gamble with your resources in a game where you don’t know the odds.
Mike Miles is a Certified Financial Planner licensee and principal adviser for Variplan LLC, an independent fiduciary in Ashburn, Va. Email your financial questions to firstname.lastname@example.org and view his blog at blogs.federaltimes.com/ federal-money.