Safety in the TSP– What Does It Cost?
The terms “safe” and “low risk” are often used to describe the TSP bond funds (G and F). When TSP investors hear that the G and F Funds are safer, many take it to mean that investing in those funds minimizes the risk of exhausting the balance in their TSP accounts before they die. Actually, they are safe one way but not so safe in other ways.
What “safer” actually means is that the G and F Funds are less “volatile” than the C and S stock funds. But that does not make them safer because volatility is not the only investment risk.
According to www.Investopedia.com, “Volatility” is:
“…a statistical measure of the dispersion of returns for a given security or market index…measured by using the Standard Deviation or variance between returns from that same security or market index.”
Plain English: The higher the volatility, the more a stock or bond fund fluctuates in value compared to its average return. Lower volatility means the value of an investment fluctuates less. Lower volatility does not mean that an investment is generating a positive rate of return. An investment that lost 1% in value every month would be low in volatility, even as its value declined.
Historically, for long-term investors in a well-diversified portfolio, a more important risk was the loss of purchasing power from taxes, inflation and lower returns.
Here is hypothetical example of high and low volatility. It illustrates investing $100,000 into the G, F and C Funds with no further contributions and no withdrawals.
The C Fund (green) investment was much more volatile than F Fund investment. G had no volatility. But 11.5 years later, the C Fund investment was worth 46% more than F and 83% more than G Fund investments. Patient C Fund investors would have been compensated for enduring much higher volatility over that 11.5-year period.
Adding withdrawals makes the safety/volatility discussion more dramatic. In the hypothetical example below, retirees Bill, Jack and Mary each have $10,000 in the TSP at the beginning of 1993. They each invest in one fund: Bill in G, Jack in F and Mary in C. They annually withdraw enough to buy 2000 First Class stamps after paying taxes of 30%.
Why First Class stamps? First class stamps are an excellent proxy for inflation. They have provided exactly the same service every year since they were introduced. When the price increased, it was not accompanied by any increase in service or functionality.
Each retiree invests the same amount and withdraws the same amount. The amounts withdrawn varied as stamp prices increased but withdrawals were always the same dollar amount for each retiree. The results:
- Volatility is lower for the G and F Fund investors. Unfortunately, their account values steadily declined to zero.
- Volatility is higher for Mary’s C Fund investment. But the value of her C Fund investment would have been 37% higher after 24 years of withdrawals.
So which is safer, Mary’s C Fund (stock) investment or Bill and Jack’s G and F (bond) Fund investments?
This is for educational purposes only. To learn more about the topics mentioned and if they are suitable for you, consult an appropriate professional. Tax laws can change at any time.
Any information provided in this presentation has been prepared from sources believed to be reliable, but is not guaranteed and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for information purposes only and does not constitute a recommendation.
Arthur Stein and Arthur Stein Financial, LLC are not authorized to give legal or tax advice. For information on your specific situation, please consult your tax advisor regarding any tax implications and your attorney for legal implications. As required by the US Treasury Regulations, you should be aware that this presentation is not intended to be used and it cannot be used for the purposes of avoiding penalties under federal tax laws.
Keep in mind that:
- Past performance is no guarantee of future performance;
- Investments involve the risk of loss of principal and earnings;
- ETFs, mutual funds, money market funds, etc. are not guaranteed by the US Government, the FDIC, a bank or anyone else.
- “Average annual return” evens out variations in the actual year-to-year returns.
- ETFs, mutual funds and individual stocks and bonds fluctuate in value and there will always be times when they lose value.
- None of the information provided is necessarily relevant to anyone’s personal situation. Circumstances differ among individuals and they should not assume that these generalizations or information apply to them.
- Investments mentioned may not be suitable for all investors.