You may get a lot of investment advice from friends and family, or you might even have a professional financial advisor. That’s great! Consider all financial advice carefully. The best advice is usually based on saving early and consistently.
The best way to achieve your retirement goals is to stick to your plan and learn how to manage risk to maximize your returns. You don’t have to know everything about investing to get started, and we’ll give you tools and resources you’ll need along the way to be successful.
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Start saving early and make regular contributions
You may have heard it said: “Time in the market beats timing the market.” For TSP participants, that wise bit of advice means that starting contributions to your TSP account as soon as possible and continuing to make those contributions regularly is more effective than waiting for the perfect moments to make or change your investments. Two of the main reasons that early and consistent saving is a good TSP investment strategy are known as compound earnings and dollar-cost averaging.
Compound earnings
When the money in your TSP account accrues earnings, those earnings begin to accrue earnings as well. That’s called “compounding.” The more savings you have, the more potential you have for larger earnings.
Snowball effect of investing early
Think of the money in your TSP account as a snowball rolling down a very tall hill. The top of the hill is the beginning of your working life. The bottom represents the point at which you want to have achieved your saving and investment goals. On each rotation down the hill, the snowball picks up enough snow to cover all the snow already in the snowball, whether that was the original snow or snow that accumulated during the roll. The snowball becomes bigger as snow gets added to it with each rotation.
When you contribute savings to your TSP account early, that’s like starting your snowball rolling at the very top of the hill. You’re giving it as much time as possible to accumulate larger amounts on its journey.
If you instead wait until you’re halfway down the hill to even make your snowball, you’re likely going to have a much smaller snowball at the end.
Of course, there will be patches on the hill with no snow to accumulate. And sometimes conditions will cause your snowball to melt some. But you’re giving yourself a much better chance of meeting your goals when you start the snowball at the top of the hill.
Compounding by the numbers
In case the snowball metaphor isn’t working for you, here’s a more literal example. Let’s say you and your coworker Emma are the same age and both start your federal careers at age 25. Emma starts contributing $3,000 a year to her TSP account right away and continues contributing the same amount until she’s 65. You wait until you’re 35 and then start contributing $3,000 a year until you’re 65. To keep this simple, assume an average annual earnings rate of 7% for both you and Emma. At age 65, you have $303,219. Emma has $640,829—more than twice as much as you!
It’s very difficult to make up the deficit you give yourself by waiting 10 years to contribute. Let’s say that, through either luck or skill, the return on your account is 10% a year as compared to Emma’s 7%. She still has $98,000 more than you at age 65. Or say you want to make it up by increasing your contributions. Even if you contributed $6,000 a year from age 35 to 65 (while Emma continued contributing $3,000 a year), you’d still have about $34,000 less than Emma at age 65. That difference is the effect of compound earnings over time.
But remember that investing isn’t a competition with your coworkers or anyone else. Everyone’s circ*mstances are different, and it’s never too late to save more. If you’re later in your working life than the people in the example and your TSP account isn’t as large as you’d like, don’t give up! In fact, it’s more important than ever to start or continue making contributions and to contribute as much as you can.
Dollar-cost averaging
“Dollar-cost averaging” refers to the benefits of making regular contributions of the same amount to your account regardless of whether the markets are up or down. It’s what you do automatically with your TSP contributions when they come out of your paycheck. With consistent contributions, you’re buying more units of a fund when the price of the fund is low and fewer units when the price is high.This table demonstrates how dollar-cost averaging benefits you. It shows what happens when you continue making your regular TSP contributions while the price of a fund fluctuates.
| Contribution | Investment Amount | Unit Price | Units Purchased |
|---|---|---|---|
| 1 | $200 | $50 | 4 |
| 2 | $200 | $40 | 5 |
| 3 | $200 | $20 | 10 |
| 4 | $200 | $40 | 5 |
| Totals | $800 | $150 | 24 |
You bought 24 units, or shares, over this period. The average unit price during the period was $37.50. ($150 divided by 4 purchases) But you only paid $33.33 per unit! ($800 divided by 24 units) That’s because you bought more when the price was low and less when the price was high. For example, with your first contribution of $200, when the price was $50, you only bought 4 units. But then when the price was $20 for your third contribution, that same $200 bought 10 units.
The more volatile the share price of an investment fund, the larger the advantage generated by dollar-cost averaging. But even in times of relatively steady prices, dollar-cost averaging is a much more reliable and profitable strategy for long-term investing than trying to predict the perfect moment to buy or sell.
Stick to your plan
Once you’ve established your retirement goals and an investment strategy that fits your needs, you’ll have the best results if you stick to your plan. Don’t get sidelined by distractions. Make adjustments to your strategy only after careful consideration.
It’s always a good idea to periodically ask yourself whether your retirement portfolio properly reflects your willingness and ability to take risk. But if you’re certain about the amount of risk you can tolerate, don’t allow short-term market movements to steer you off course.
Suppose, for example, that you have many years before retirement, and you’ve determined that investing in the TSP’s stock funds is appropriate for your time horizon because of the potential for higher long-term returns. If you move your money out of your TSP stock funds when the market starts to dip, you may miss out when it bounces back.
An investment strategy of chasing returns or trying to “time the market” means you must be consistently correct two times: exactly when to get out of a particular asset class and exactly when to get back in. Most investment experts agree that such success is highly unlikely over long periods.Remember, your investment performance is determined, in large part, by your asset allocation, not by guessing which market sector is going to be in favor at a particular time.
Manage risk over time
There’s always risk associated with investing. But don’t let the risks prevent you from developing and maintaining an investment strategy through each phase of your working years. How you distribute your money among the TSP funds should reflect your time horizon, or when in the future you’ll need retirement income, and your risk tolerance.
If you want to choose an investment option that will adjust automatically to manage risk over time, consider the Lifecycle Funds (L Funds). They rebalance every day to maintain the appropriate investment allocation, and they reallocate over time to give you less risk the closer you get to needing your money.
Early career
Since you have many years ahead of you, you can probably afford to take some risk. You might consider investing more in our stock funds (C, S, and I) than in the more conservative G and F Funds at this stage of your career. Stocks present more risk but offer the opportunity for potentially higher returns over time.
Mid-career
If you haven’t started saving for retirement already, it’s not too late—start contributing now. And if you’ve been saving steadily, keep it up.
At this stage of your career, your time horizon is shorter than when you first started working. This might be the right time to revisit your investment allocation to assess the amount of risk you’re taking in your TSP account. That is, if you’re heavily invested in the TSP stock funds or solely invested in the G Fund, you’ll want to be sure that your allocation is appropriate, given other retirement resources you may have.
Nearing retirement
The closer you are to retirement, the shorter your time horizon. As a result, your primary focus might shift from growth and accumulation to safety and preservation. Even if your risk tolerance is very high, you may not have time to recover from severe drops in the market if a large portion of your account is allocated to stock funds. If you need to use your money soon and the stock markets take a downturn, you may be forced to “sell low,” which you never want to do.
Retired
You’ll likely spend many years in retirement, and you want to make sure you won’t outlive your money. It’s important to develop a withdrawal strategy that provides you with the retirement income you need while the rest of your savings still has opportunity to grow beyond the pace of inflation. For an example of how to invest your money with the goal of preserving assets, look at the allocation of the L Income Fund.
For even more information on investing and diversification, visit The Pension Protection Act: Investing and Diversification.
