During retirement: take small financial steps (part 2 of 2)

The first post of this series talked about small financial steps to take during the first few months of retirement.  We’ll close by considering how to handle your tax-deferred investments in the Thrift Savings Plan and what other adjustments you may want to make to your investments.

When you leave the military, whether by separating or retiring, you can transfer your Thrift Savings Plan. You could roll it over to an IRA or possibly some other tax-deferred investment account, and you could even work out a temporary withdrawal plan for more income until you reach the minimum age for penalty-free withdrawals. In an extreme case you could even cash it in (after paying heavy penalties and taxes) and use the money for other purposes.

However the best option might be to leave your investments in the TSP. You’ll continue to enjoy tax-deferred compounding of your assets as long as age 70. Your money is in funds with some of the world’s lowest expense ratios, and the fund custodian doesn’t use marketing gimmicks or other relentless sales pressure. If you decide to change your asset allocation then you can easily move your TSP holdings among their major asset classes without paying any fees or other penalties. If you retire before the minimum penalty-free withdrawal age of 59½ then you may want to consider reducing your future taxes by rolling your TSP account over to a conventional IRA and converting it to a Roth IRA. But you may also be quite satisfied to leave your investments in the TSP until you reach age 70 and then withdraw them as an annuity.

At the time of writing this post, legislation for a “Roth 401(k)” may be extended to the military as a “Roth TSP”. This would mean that after-tax earned income could be contributed to the TSP. This is a huge advantage over contributing after-tax income to a 401(k). The 401(k) programs of most civilian employers have annual expense ratios of 0.75% or even higher. The TSP’s expense ratios of 0.03% make it a much more attractive alternative!

The country song advises “Live like you’re dying”, but you may want to invest like you’re immortal as you enter the withdrawal phase of your portfolio’s financial management. While you were on active duty or in the Reserves/National Guard, you may have cut through the “fog of work” to decide to put in enough time to earn a pension. Now that you’ve finally made it, your pension could be your greatest asset because it guarantees a minimum standard of living no matter what happens to your other assets. If you retired without a military pension then perhaps it’s worth buying a single-premium immediate annuity to pay an insured minimum income during your retirement. Social Security is an annuity, but other guaranteed income ensures a minimum quality of life to help you be more confident about the market risks you take with the rest of your investments. Review the “tailor your investments” post and decide whether an annuity is appropriate for your situation. Reassess this decision every few years during retirement.

There are other options to create a lifetime stream of income without consuming your principal. A riskier alternative to annuities is stock dividends. When you were earning a military paycheck and saving for retirement, you were investing aggressively and seeking strong growth from your equities. Growth stocks still have a place in a retiree’s investment portfolio, but you might be more comfortable with a steady stream of dividend payments to complement your pension.

During a bear market, another way to prolong your portfolio’s survival is to stop withdrawing from it until it recovers. If you choose to maintain a high asset allocation of equities during retirement then make sure that you have enough spending cash to ride out downward market volatility and the recovery from a recession. (Nobody worries about upward market volatility!) While you were earning a paycheck you were confident that you’d be able to replenish your emergency funds in a few months. You were also setting aside savings for short-term goals like a new vehicle or the down payment on a house. In retirement you need to keep at least a year or two of savings in cash to pay your expenses if your portfolio drops by 25%. (Even retirees still need to set aside funds for short-term goals like a new vehicle or replacement appliances.) Most bear markets have lasted for two years and some have been even longer. Many retirees keep their cash reserve in CDs to pay a minimum of 2-5 years of expenses beyond those covered by their pension and investment income. Tailor your own cash reserve to your comfort level, your asset allocation, and your willingness to seek part-time or short-term employment. You can also spend down your principal if you expect it to last for the rest of your life. But if you’re blessed with unexpected longevity and no longer able to hold a job, then your only other option would be to cut back your lifestyle to live within your pension.

If you elected to have survivor benefits paid on your pension then check this arrangement every few years to make sure that it meets your beneficiary’s needs. You can’t change your military pension’s survivor benefits but you could consider other life insurance or change the asset allocation of other investments.

[Note:  I'm drafting a post about the military's Survivor Benefit Plan.  Send me a comment or an e-mail if you'd like to share your experience.  Thanks!]

A word of caution about maintaining your retirement investments: don’t make it any harder than you want to. You don’t have to be an investment guru unless you want to be one. You may have the time to spend hours day-trading futures contracts, but you shouldn’t do so unless you find it fascinating or entertaining. Picking individual stocks may seem like a great way to generate extra spending cash, but it also requires a considerable commitment to research and tracking. Only a small fraction of investment professionals are able to beat their market’s returns, and there’s no reason to expect that you’ll be able to do so without investing at least as much of your time as your money. Even if you are able to beat the market, it’s hard work and it requires constant effort. Maybe you’re wondering if you’re the next investment genius to beat Warren Buffett’s record, but he exerts a tremendous daily effort on research and analysis that borders on obsession. If it seems like the life for you, then take a small percentage of your assets– 5-10%– and explore your curiosity to your heart’s content.

“The Military Guide” is full of real-life examples and stories from over 50 veterans.  I don’t usually include those in the blog (you’ll have to read the book!) but here’s a cautionary one on how to over-complicate your investments:

When I ER’d I was supremely confident of my investing abilities. After all, I’m a highly trained veteran who’s spent over half my life making quick decisions with incomplete information under life-threatening stress. I wasn’t going to spend the rest of my life wondering how good I was– I was going to find out while I still had my sentience and courage, and I’d dispassionately benchmark my accomplishments against the professionals.

When I inherited a few thousand dollars I set up a brokerage account with all the features: real-time streaming quotes, low commissions, fast execution, margin loans, options leverage, and everything that Wall Street (and the Internet) can give to us retail investors.

Over the next five years I read and researched for several hours a day while working through all the investing styles. I educated myself and tested my mettle through day-trading, momentum investing, value investing, technical analysis, penny stocks, microcap stocks, commodities, real estate investment trusts, initial public offerings, limit orders, stop-loss orders, automated quantitative-analysis trading systems, shorting, options, and a whole dictionary of stock-picking acronyms.

Experience proved to be a quick and brutal teacher with expensive tuition. Surprisingly, each year I got a little better. My analysis and critical-thinking skills improved. I learned how to read financial reports and arcane SEC filings. I studied accounting analysis. I learned how to build spreadsheet models of revenue and cash flows. I caught several trends and made huge short-term capital gains in some stocks while getting savaged in others. I made better choices and fewer mistakes.

During the fifth year it all came together, leaving me with a difficult decision– continue the experiment or take my profits? One choice made itself when valuations went from “high” to “bubble” and I cashed out. I looked for other undervalued stocks but everything seemed richly priced. It was time to start shorting the market.

I abruptly realized that I was no longer enjoying myself. I’d learned a tremendous amount and I’d been able to (eventually) apply it with extremely gratifying results, but I was spending over 20 hours/week on research. I was also tired of tracking the positions and dealing with the daily stress of the critical details– and there were a lot of critical details.

When I analyzed my latest short-term results I saw that I was barely ahead of the market. I was winning the race, but I was running hard to stay ahead of the pack. Over the five years that it took me to accumulate my knowledge and experience, I’d only managed to beat money-market returns. Meanwhile a stock index fund would give me market returns with a tenth of the effort. I elected to return to index funds so that I could enjoy more time with my family– and more fun.  I may never completely quit stock-picking, but I don’t let it become a time-consuming job.  I’d rather have a life.

Related articles:
During retirement: take small financial steps (part 1 of 2)
Retiring without a military pension
Retiring on multiple streams of income
Retiring from the Reserves and National Guard
Retirement budgeting

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