So where should I invest my money now?!?

Cherie asked a very pertinent question in the TSP post:

 I joined the Navy in 2002 and contributed to TSP until I got out 5 years later. Since I have gotten out I have lost over 1/2 of the money in my TSP. Should I just leave it there and let it do its thing or should I take what is left and roll into a Roth IRA? I’m only 28 so figured that leaving it alone would be ok but just not very confident in the markets anymore and want to make sure I am doing the right thing with my money.

Thanks for your comment!

One of the world’s most frustrating things is watching an investment lose money yet not knowing where else (and “when”) you could have put it. You might not only lack the knowledge, experience, or time to do something about it– there might very well be no place left to hide from a bear market. Spouse and I know what it feels like. During the “Black Monday” of 1987 we finished the day over 20% poorer– in one freakin’ day. In 2001-02 we watched our portfolio melt down by 40% of its value like an ice cube on a Hawaii sidewalk, and nothing we did seemed to make the slightest difference. During early 2009, our portfolio was down over 50% from its 2007 highs. I did a lot of research back in 2008-09, and I know there was no place to hide.

When you left the military in 2007, your TSP was probably at an all-time high. It was certainly at least 20% above the market’s long-term performance levels, and maybe even 40% higher.

One comfort we could count on through Black Monday and 2001-02 was that we still had our military careers. We kept saving for retirement, confident that we’d be buying our next few months of investments on sale. But it was pretty nerve-wracking to retire during the summer of the 2002 market, knowing that I wouldn’t have those steady paychecks to invest anymore. It was even more exasperating watching our portfolio hit its 2009 low. Intellectually, I’d done the math and knew that we could survive. Our portfolio would recover. We wouldn’t even need to cut expenses, let alone look for jobs. But all that academic research & analysis sure didn’t make me feel better, especially the parts where I had to explain my “investor logic” to my spouse. You’re seeing the same issues in your TSP statements.

Another comfort (such as it was) during all of those times was having a plan: we’d done a lot of reading after 1987, and we’d created our asset-allocation plan. We wanted to invest as much as we could in high-quality stock funds with low expenses for at least the next 15 years, and maybe the rest of our lives. We knew that our retirement portfolio would be very volatile but that after 10-20 years its returns would probably beat the averages of bond portfolios, real estate, and commodities. Once again the problem with that research is living through a bear market’s downward volatility. (Nobody complains about a bull market’s upward volatility). It’s a terrible feeling to watch your investments lose so much value, but it’s even more painful to have to look at them while waiting for them to recover. Did you read the right books, and understand them? Was your analysis correct? Did you miss something? Did you make a math mistake? Did you choose the right decisions? Will this portfolio make money ever again?!?

Human psychology magnifies this pain. We don’t watch the market go to new highs and think “Well, it’s 30% above its long-term average, but we don’t really own any of those gains unless we cash out. Even then we’d have to pay taxes. Besides, if we cashed out then we’d have to time things absolutely perfectly, both at the top and again at the bottom, or else we’d miss out on more long-term gains. And when it goes down then it could drop 30%-40% below the long-term average for a few years, so timing is extremely hard and usually wrong. Cool. Let’s go surfing.”  Nope. If you’re like me, you’re thinking “Party!!!!” “Golly, I might be able to retire early!”  Mentally and emotionally you’ve decided that you already own that money, even though it’s still invested in a volatile asset.

When the inevitable “reversion to the mean” occurs, the new bear market almost always overdoes it and plummets below the averages for months. Again our emotional human psychology makes this far worse. We don’t think “Hey, fire sale on stocks, let’s go buy more!” Instead we mourn our recent losses  (taken from the gains that we didn’t own in the first place) and wonder if we’re ever going to see them again. A few sell out at the bottom, locking in their losses and permanently eliminating their chances to recover. We worry that we’re going to end up working until we die. Life is bleak, and now we have to figure out what else we should invest in.

The key is having a plan before the pain starts.  Most importantly, your plan has to match your personal tolerance for volatility with the market’s inevitable (and seemingly psychotic) behavior. A notorious boxer once said “Everybody has a plan until they get punched in the face.” You need a plan that you can live with while you’re trying to stay conscious and get back up off the canvas.

OK, Cherie, back to your question.

The first two things to decide are what you would do with your TSP assets and when you would do it. At age 28, it sounds like you’re planning to keep saving for retirement. It doesn’t appear that you need to tap into it now for retirement income, so you could leave it in the TSP for at least another 10 years– the “long term”.

It also doesn’t sound as if your asset allocation plan involves any exotic IRA investments. Even if you were investing in assets beyond the traditional stocks & bonds, some portion of your plan probably still includes stocks & bonds– and those portions could be handled by the TSP’s fund choices.

Your long-term goals could still include the TSP’s funds, but now you might be wondering if there’s a better mutual fund or stock or bond. The advertising of the financial industry and the investment magazines certainly makes it seem that way. However, the reality is that most of a retirement portfolio’s returns depend on its overall asset allocation. About the only things investors can control are that asset allocation and its expenses.

The TSP’s funds have the world’s cheapest expense ratios.  Their returns are very close to their benchmark index, and they’re passively managed. You can get most of the market’s overall return with very little personal effort. This means you don’t have to worry about investor’s money chasing a hot manager (“inspired” by those magazine articles on “10 Great Funds to Own Now!!”), forcing him to find new investments and making it difficult for him to keep up his long-term record. You don’t have to worry whether that manager will stick to the reasons you bought the fund and stay on the job. You also don’t have to work as hard as Warren Buffett to find your own investments and keep track of their performance. You can focus on the things you’re good at– your career and saving money for retirement– and let the market’s performance return to its long-term averages. For 95% of us investors, passively managed index funds are the best approach. The TSP has the world’s largest (and cheapest) passively managed index funds.

It’s frustrating enough to lose profits (whether you “owned” them in the first place), and it’s even more frustrating when there doesn’t seem to be any place to invest the rest. Your losses over the last four years have included one of the market’s biggest rises and steepest declines since the Great Depression. Every equity fund (and quite a few bond funds) got hammered by the overall market conditions. The vast majority of investment portfolios still haven’t recovered from the 2007 highs and some may not recover for another decade.

Your only consolation may be comparing the performance of the TSP’s funds over the last nine years to the performance of other mutual funds.  After fund expenses, you probably have more money left than most of those other funds would have salvaged by having to pay higher expenses during the same bad market conditions. In other words, it could’ve been uglier and the TSP sucked less than most. But our human investor psychology means that’s not much consolation.

So where do we go from here, and how do we avoid feeling this way again?

One way is to try to change your attitude. (This is hard but worthwhile.) The “good news” is that you’ve come through one of the last century’s most intense investing crucibles. You’ve learned far more about volatility at a far younger age than my generation ever experienced. You can apply that experience in your asset allocation plan. You can decide to put up with the future extremes of volatility because you have time enough to recover before retirement. Instead of obsessing over paper losses, you can focus on the opportunity to buy discounted assets for future gains. The trick with this approach is to not panic and sell out at the bottom of the next bear market.

Another option would be to decide that you don’t want your investing life to be quite so exciting. (Unfortunately this could also make your working life longer.) If you want to reduce the extreme highs of volatility of your portfolio then make sure you’re invested in a diversified variety of assets– stocks, bonds, and CDs/money markets. If you want to reduce the long-term average volatility of your portfolio then invest in lower-volatility assets: more bonds or cash and less stocks. I’d strongly urge you to try to keep investing in a high-equity portfolio as long as you have employment income. You’ll have to find a way to cope with the emotional whiplash (“Well, I’m buying more stocks on sale this month and my portfolio will eventually recover”) but you’ll be maximizing your human capital.

So your first step is to refine your asset allocation plan. You have to find the one that works for you, not the “hot fund” approach. Think about how you’ll feel when your plan punches you in the face, and how you want to deal with those feelings. If your asset allocation plan included 70% stocks and you just don’t want to see that volatility again, then consider reducing that to 60% or even 55%. You’ll give up some long-term gains in exchange for reducing the swings of volatility. You won’t enjoy higher returns over the next decade, but you won’t see nastier drops during bear markets. Raise your asset allocations to bonds or to cash, even though those aren’t very good places to be right now. If inflation takes off (and it’s already stirring) then your bonds may underperform for another year or two. Even your CDs won’t be keeping up. But bonds won’t be oscillating as wildly as the stock market, and CDs won’t lose principal.

In the TSP you may want to reduce your holdings in the C, S, and I funds. They’re good investments to own, particularly the S & I funds, but if you don’t want the volatility roller-coaster then you should own less of them. You might want to buy more bonds in the F fund, although good bonds are just as tough to find these days as stocks. I’d stay away from the G fund– you’re still working and you don’t need to eliminate the risk of loss of principal. If you’re nervous about a layoff then put more cash in your emergency fund.

If you want to put this plan in autopilot, then put your TSP contributions in a life cycle fund.  They’re made up of the TSP’s other five funds but as you approach retirement they’re rebalanced to reduce their volatility (and their risks of loss, but also their returns). For example the L2050 fund  has a higher allocation to the C, S, and I funds, and much higher volatility, than the L2020 fund. The L2020 fund  is mostly invested in the F and G bond funds to minimize volatility and reduce the risk of loss of principal. Depending on how much volatility you want to live with, you might choose the L2030 or L2040 funds. If you’re comfortable knowing that the TSP’s L fund is rebalancing every three months, then that confidence might make you perfectly happy with the L2050 fund.

Keep an eye on the TSP’s plan to start a Roth option in 2012. You might even be able to roll your Roth IRA into the TSP, which would immediately reduce your expense ratios.

For your other tax-deferred accounts (like 401(k)s or 403(b)s), try to find the lowest-cost index funds that they have available to fit your asset allocation, and make sure you maximize your employer’s match. In your taxable accounts, seek out low-cost index funds that fit your allocation plan. These would certainly be Vanguard or perhaps Fidelity funds. They also have lifestyle funds similar to the TSP’s L funds, although with much higher expense ratios.

That’s what should work best for you, Cherie.

What are spouse and I doing in retirement, after our third experience with extreme volatility? I’ll cover that in another post.

Please do us a favor– check in occasionally with an update.  We’d like to know how this is working for you and, more importantly, what lessons you want to pass on to other investors going through the same experience. Thanks!

Related articles:
Tailor your investments to your military pay and your pension on investment allocation
Read the first two subjects in the “Topics” box, starting with “Investment policy statement”
Recommended reading
Try “The Boglehead’s Guide to Investing”, “Work Less, Live More”, and “The Four Pillars of Investing”.  In that order.

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WHAT I DO: I help you reach financial independence. For free. I retired in 2002 after 20 years in the Navy's submarine force. I wrote "The Military Guide to Financial Independence and Retirement" to share the stories of over 50 other financially independent servicemembers, veterans, and families. All of my writing revenue is donated to military-friendly charities.

  1. I retired this past January and looked at possibly transferring from the L2040 fund to Edward Jones managed funds. Edward Jones beat TSP by 2% however there is a high front end load or a fee of 1.75% per $10,000.00. TSP has a low maintenance fee. I’m holding the course and staying with TSP.

  2. Thanks for including me in your blog and responding to my question. Been real tired lately so still reading through it so that I can understand it all (long work days while I’m in Iraq).

    Off first thought I think I will go ahead and leave my TSP money where it is. I am invested in the L funds and if I recall correctly I’m invested in a couple of them just to diversify more. I have also ventured into etrade over the last year and like some of your other recommendations. They are making me feel a bit safer about my choice in that. I hope to invest a little more into the market this year now that I have a bit of confidence after hearing your past experiences.

    Thank you for taking the time out to respond and I will finish reading through the post and talking it over with my boyfriend and let you know what I decide to do long-term.

    Comment? Question? What's on your mind?