How to Invest TSP When You Have a FERS Pension

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one of the most important decisions you can make about your retirement plan is deciding which investment selections you're going to use to help you meet your goals and the right way of doing this is to make your decisions within the context of the rest of your plan to include your sources of fixed or guaranteed income as a federal retiree you're likely going to be receiving a fur pension as well as Social Security and if you're not including these in your decision-making then you're probably going about it the wrong way so today we're going to cover how to use your pension and social security as a part of your investment allocation so that you have the right mix for you and so here's the question Thiago I know that in my retirement my portfolio has to generate stable income for me to meet my ongoing expenses as a federal retiree I'll be receiving a decently sized pension as well as Social Security how should I be thinking about my investment allocation as I create and adjust my retirement income system so this is the question we're working with today and essentially they'd like to know how they should think about their fixed income portions such as fur pension and social security as information that's going to influence their retirement portfolio and I want to answer this question by starting with what is the wrong way of going about doing this now before we jump in folks remember I am not your retirement planner I don't know your specific circumstance so it goes without saying that anything we talk about here you need to check with your advisers too there's a lot of context and specifics that I leave out for the sake of time so don't take what you hear today and go play the role of an adviser okay so when it comes to portfolio this is a rather technical part of a retirement plan so there's a little bit of portfolio theory that we're going to cover so again we're starting with the wrong way of creating your portfolio when factoring Furs and Social Security before retirement creating your portfolio allocation is pretty simple right you've got a lot of time before you actually need to retire so really you're investing for growth along the way because you want that long-term accretion of your portfolio and so a lot of federal employees are very aggressively invested in the Cs and I funds or maybe they're using some of the life cycle or if you've got other accounts using things like stocks and this could be a solid strategy for people who aren't close to retirement in fact it's likely what you've done over the years and probably what's allowed you to be successful in building your wealth to the point that it is today the problem is that this doesn't work in retirement I think many of you understand why being 100% in stocks may not be appropriate in retirement and a lot of you probably will do something different but often times we find that the way people go about making their allocation isn't the right way to do that most of the time and this is if you're working with an adviser or you're filling out one of those online questionnaires for your accounts whatever the case might be they'll ask you to fill out a questionnaire that answers things like what's your age and how long before you need your Investments what's your general feelings about Market volatility or even sometimes how much of a decline would you be okay taking in your portfolio before you get really nervous and a variety of other questions like this and what this is designed to do is that it's a tool to simplify creating a portfolio allocation based off of how you respond to those questions and most commonly and if you're like most people coming up to retirement you're probably going to get a portfolio allocation that looks something like 60% in stocks and 40% in bonds now there's nothing inherently wrong with a 60/40 portfolio but that might not be the right portfolio for you in your situation remember your Investments should be tailored according to your whole retirement plan and those questions are really just scratching the surface about your needs in fact I'd argue that it's no more likely to be the right portfolio compared to a 50/50 or even maybe a 7030 so remember this is a generic starting point and yes there are benefits to a 60/40 portfolio but we're not looking for a general portfolio we're looking for the right portfolio that's going to help you meet your objectives in retirement for as long as you live when you're younger and the markets don't perform as well as you'd like them to that's okay it's not the end of the world you still have a lot of time that you can allow the markets to recover once again but in retirement you don't have that kind of time so a good enough portfolio really isn't good for you at all plus it also doesn't cover what kinds of stocks are going to be most appropriate for you and same thing with bonds for example should all of your stocks be in something like the S&P 500 or this would be like the tspc fund that can be very volatile and in a year like 2008 to 09 your stocks might have lost almost half of their value in just under a year and a half so if getting your allocation just from these questionnaires is the wrong way to go about it then let's talk about the right way to approach managing your portfolio in retirement there are two components that I want you to focus on when you're thinking about your portfolio allocation ask yourself the following questions what is my attitude towards taking risk and what is my aptitude towards taking risk set another way what is my capacity of taking on risk in my portfolio and being more growth oriented and next what are my general feelings with investing in a way that's going to provide me with that growth and folks this is really important so let's break this down individually and we'll start with your aptitude or your capacity for taking on risk let's assume that you need to take $5,000 from your portfolio to support your lifestyle needs and let's also assume that you have about $1.2 million in Investments taking 5K a month for 12 months means $60,000 a year which represents a 5% withdrawal rate from your portfolio now let's say that your portfolio was 100% invested in stocks well when we look at total stocks over the last 100 years or so on average we've seen somewhere between 9 to 10% annualized returns so if we look at this it seems like the math checks out right we're earning 10 % we're taking 5% withdrawal there's still 5% in our portfolio that's left inside and by the way this is what Dave Ramsey was talking about very recently when he was saying that you could take 8% out of your portfolio because if you're earning 12 and you're taking eight you still have four left over if you haven't seen that video it's quite interesting and you should check it out if you get a chance I don't think the right message came across like he wanted but nevertheless this is what he was saying so I average 10% I take out so there's still money left over and that seems to work until you recognize that you don't get a 10% annualized return every single year in the markets in fact never once in the last century has the stock market given exactly 10% in a single year you're going to get returns that are much higher much lower or anywhere in between the average annualized returns in fact if we look at history there was a year that you could have earned as much as 54% in other years where you would have have lost 43% and if you apply either one of those scenarios in a retirement scenario you're going to get completely different results the risk of the markets not performing consistently the same every year which is guaranteed to happen because that's how the markets work this is called sequence of returns risk and let's look at an example together again we'll assume you're starting with a $1.2 million portfolio and you're taking $5,000 a month which is 60,000 per year now let's also assume that your port experienced a really bad year year and a half in the markets like the one that had 43% negative returns well you started the year with $1.2 million throughout the year you took out $60,000 you would have ended the year with just under $650,000 and now let's play it out for another year let's say you need another $5,000 a month for a whole another year which again makes up $60,000 per year and suddenly your 5% withdrawal rate that you had originally started with with is now closer to 99.2% withdrawal from your portfolio so that means that your portfolio is going to have to grow by 9% that year just to stay even and not to mention keep growing for you because you have to outpace inflation so that you can take bigger portions out in the future to keep up with Rising costs and when we look at a 9% portfolio withdrawal rate that has a pretty low probability of success and this is the case even in more stable Market environments too and so that's the problem your portfol or this situation doesn't have the capacity to take on that level of risk being 100% stocks in this scenario would be much too aggressive and not sustainable so then you think well yeah Thiago everybody knows 100% stocks is too aggressive for retirement right but then how do you figure out what's the right amount of stocks for your retirement portfolio and how do you factor in the fact that you have a fur pension or an annuity and Social Security that's providing you with some of the income you're going going to need in portfolio management Theory there's a concept that seems to be quite contradictory to how you want to invest it states that an Investor's portfolio allocation should be the most conservative that it can be while still being able to achieve that Investor's goals now I'll be the first to tell you that life doesn't happen as it does in theory books the difference between theory and practice is that in theory they're both the same but if we analyze the statement further then we understand that it also means that an investor should take the least amount of risk necessary to be able to achieve their goals and when we say it this way it starts to make a little bit more sense in the long term we know that stocks provide an opportunity for growth so long as you have a long enough time Horizon but you've heard me say before that volatility is expected when we are shooting for growth volatility is the price that we pay for the opportunity of long-term growth but that means that in the short term like when you're retired and drawing money from your portfolio that volatility represents risk to you and this risk within the context of a retirement plan represents the possibility of permanent loss of capital which means that your retirement plan may not be successful if we go back to our example of having 1.2 million and needing 5,000 a month well you may be forced to sell your portfolio at a loss to generate this 5,000 and that creates a permanent loss of capital for you this is one of the major challenges that the tsp and other 401ks have when taking distribution across all Holdings so back to your capacity to take risk how much do you need in a more conservative bucket so that you're not having to sell your Investments at a loss when you need to generate Capital well in general and folks I really do mean very general we would start by looking at roughly 5 years worth of liquidity needs and why do we say 5 years well there's a couple of reasons the first is that on average a bare Market cycle back to even so this means from Peak to trough back up to even once again takes roughly on average 2 and 1/2 years to get back to that so if we look at 5 years you're essentially giving yourself a little bit more time in a cushion for the markets to recover again now it's important to understand that it could take longer than 2 and 1/2 years for example if we look at the S&P 500 Index this is 2007 and this is 2014 right around here in October of 2007 we had the peak that began this very large Decline and you'll notice that it was not back to even until almost 5 years after that event and we also saw something similar like this from August of 2000 all the way to 2006 when we had the Technology stock bubble now obviously your stock Investments shouldn't be made up of only S&P 500 index funds because this creates an incredible amount of volatility and risk in your portfolio but you get the idea now we also aren't looking at the Great Depression years and there's a number of reasons why that's less relevant to planning done today but that's beyond the scope of this video so back to our example with 1.2 million needing 60,000 a year if we look at 5 years worth of income we're talking about $300,000 in a bond allocation or non- stocks for your portfolio now bonds can be treasuries they can be short-term bonds long-term bonds corporate bonds high yield bonds even money markets or CDs there's a whole bunch of options for you to be creating the income that you're going to need in retirement and each of them is going to behave a little bit differently depending on what's going on in the economy so just understand that when I say bonds I'm really just using a catchall to talk about non-stock allocations of your portfolio you want to make sure that you own the right combination of these so that you have the best protection available in your portfolio so if we have 300,000 in bonds that means theoretically we're sitting on $900,000 that can be invested for you more aggressively in things like stocks so very simplistically this means you're looking at something like a 75% stock to 25% Bond allocation now there's a lot of variables that I'm just glossing over here that you would want to apply in your circumstance understand that this is just a starting point for example one of them is really important and that is inflation you're going to need to factor in the fact that 5 to 10 years from now whatever you're taking out today is going to need to be higher to keep up with the ongoing cost of living that increases over time another is taxes remember that every financial decision that you make in retirement comes with a tax consequence if you need something like $5,000 a month that's probably after taxes so you have to factor that in too and understand this is an oversimplification but I want you to start getting an idea of how to be thinking about your own portfolio if you are not careful about how you're drawing your income you could be paying much more in taxes and retirement than you really really needed to another important one is market returns the sequence in which you receive the returns that the markets are able to give you is going to have a huge impact on the outcomes of your retirement and there's a really interesting graphic designed by black rock that highlights how this works what we have here is three different portfolios all of which received the same 7% annualized return the only thing that was different is the sequence of the returns that the market provided and we can see here that there's actually three different situations all together three different end points that these portfolios experienced when drawing money from their portfolio this is because your performance is important of course you need to be outpacing inflation but your investment performance is not important enough if you get the other components of your retirement plan incorrect like overpaying in taxes or not withdrawing from the appropriate accounts and Myriad others so in theory if your Social Security and your pension income meant that you didn't need to touch your portfolio when it was reduced in value at all then technically your capacity for taking risk is actually 100% but the reality is that nobody wants to have a retirement plan that's entirely dependent on what the markets are doing in any given year in fact the ultimate definition for a successful retirement in our view is the ability to continue living your life and doing the things you really want to do what's important to you and what's really fun regardless of what's happening in the markets and this means not only having just your needs met but also having your wants and desires being able to be accomplished as well you wouldn't want to stop all of that traveling for three or four maybe even five or more years and not really be able to enjoy your golden years and retirement just because the markets aren't performing that well having to do this means that your plan is probably not set up correctly your first pension and social security will provide some of your monthly income needs but if you're anything like our clients then your savings are are going to supplement your income and allow you to enjoy living a life that is really satisfying to you now I said that this is a very basic starting point to be thinking about how to create your portfolio and some people might be thinking well if this is basic then what else do we have to be thinking about as well this already sounds like a pretty good place to start and maybe end too the key here is that even if you have your stock to bond allocation which kinds of stocks we talked about various different bonds earlier stocks and bonds have a lot of variety and each one is going to do a little bit of a different job in your portfolio so creating a combination of various different types to help best meet your needs is going to be key here for example when we're looking at the total returns of a particular stock index some of that is going to be the actual price accretion that you're starting to see on the shares but there are also dividends that can be paid to the portfolio as well or if we're looking at bonds then we're actually looking at the percentage yield that those bonds are paying into the portfolio as a form of income in cash flow and if we see that hey the cash dividends that are being HIIT in a portfolio is sufficient to cover the cash flow that you need then one could theoretically argue that you don't need to sell any of the stocks dividend income tends to be pretty sticky even if the price of the stock is not doing too well but again you need to be thinking about a net after tax amount on these dividends or on these interest payments that you're receiving on any of your Investments so you can really start to see that there's a lot more layers that become involved Beyond just saying hey I'm going to hold 5 years worth of my income in bonds or more conservative Investments but the key here that I want you to get is that the higher or more income that you have in Furs pensions or your military pension or social security or the combination therein then that means there's going to be more influence to how you should be adjusting your portfol pfolio in your own retirement plan now all of this has been from one standpoint which is your aptitude or like we talked about the capacity for you to take on risk but the other standpoint is actually your attitude towards taking risk and before I jump into that if this has been interesting or helpful or if you've learned anything then let us know by hitting the thumbs up on the video for us and now let's talk about your risk tolerance or your attitude towards taking on portfolio risk federal employees in general tend to be more risk verse again I know it's not every fed but if we're looking at the community as a whole you will find that The Closer a federal employee gets towards retirement and as they age the less comfortable they're going to be with taking on higher levels of risk in their portfolio and so far we've paid absolutely no attention to any of the emotional side of investing now if we were to incorporate the fact that you're human and that you have a pulse then that means you have some general feelings about how you're invested and the kinds of risk that you take and the reality is that we're not computer softwares or spreadsheets that can withstand Market downturns with no impact to how we feel even if we're comfortable being a long-term investor you do still wish that a downturn didn't happen and it's likely going to influence your decisions about money in some way so maybe an 8020 or possibly even 100% stock portfolio could meet all of your income needs in the form of dividends or however we're structuring it but is that the right portfolio for you now to put this in perspective let's say you have a million5 in your portfolio and over the course of a year or a year and a half you experienced a 43% decline like we've seen in history before this would make your portfolio drop to about $855,000 after that how does that make you feel terrible right it would feel like a huge setback because it's probably taken you decades to build your portfolio to that degree and in 16 short months possibly your portfolio has been decimated to below a million dollars and to compound it every news station is going to be talking about the worst is yet to come and to expect more pain and suddenly your golden years feels like they've gotten turned upside down and the reality is that they don't know exactly what will happen but the message to you is going to be clear that uncertainty is on the horizon and I can promise you you're going to be glued to the TV if that happens to you so you can see that your risk tolerance or your attitude towards taking risk is all about what's your comfort level with the degree of volatility that you might experience in the short term you can't be too conservative because if we pay too much attention to how we're feeling then you might not be growing your wealth fast enough to pay yourself in the future with inflation adjusted withdrawals that means we might miss the financial component if we're focusing too much on how we feel but on the other hand if we're focusing on just the investment side and maximizing our wealth then we might drive ourselves crazy when the markets really don't do what we expect them to and this can create a lot of discomfort in the years that are meant to be enjoyed and having a great time with your family with your friends and enjoying the fruits of your labor I often show clients this vend diagram of how real retirement planning lives somewhere in the middle of what's best for us financially and what really makes us happy in life so when you're looking at this for yourself your first pension and social security absolutely have an impact to what your portfolio should be doing as it supplements your lifestyle but on the emotional side of things those two forms of guaranteed income might make you feel more comfortable with taking on a little bit more Market risk but then you also have to ask yourself how are you going to feel when volatility hits once again and so we talked about how taxes has a huge impact on your plan and if you haven't seen this video that we made on how to keep your taxes lower in retirement then make sure you check that out next and if you're a late career fed and you're interested in how we help our clients have a better retirement check out our website at the fedc corner.com and until next time stay wise and stay [Music] wealthy
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Channel: The Fed Corner - Federal Retirement Planning
Views: 18,975
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Keywords: the fed corner, tsp, FERS, OPM, Federal Retirement Planning, FERS Planning, FERS Retirement, FEHB, plan my federal retirement, plan your federal retirement, my federal retirement, SES
Id: CBDjRYs4nfY
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Length: 22min 8sec (1328 seconds)
Published: Sat Nov 18 2023
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