Want to Retire Rich? Don't Worry So Much About Performance

[Mike]

http://money.cnn.com/2005/12/16/retirement/updegrave_money_0601/index.htm

The gist of this article is that the real difference in your 401(k) balance is made due to your contribution rate, not the funds that you pick (I'd say this is mostly applicable to those under the age of 45).

[cowboy]

I love your article Mike!! This is the exact reason why Cowboy doesn't worry at all about the funds and the little short term moves!! Make a New Years gift to yourself everyone and sock it away it will pay!

[Sr]

Mike wrote:
http://money.cnn.com/2005/12/16/retirement/updegrave_money_0601/index.htm

The gist of this article is that the real difference in your 401(k) balance is made due to your contribution rate, not the funds that you pick (I'd say this is mostly applicable to those under the age of 45).

A 401k paticipant who does not have to put up with the fees Putnam charges would be much better off regardless of fund performance. Now, if TSP can charge 6 basis points to manage a fund, how much would you like to pay Putnam, if you had your choice?

Yeah, unfortunately not many Putnam 401k investorsarein Putnamby choice.

[Griffin]

This was shown to me over the summer which is what got me thinking about my TSP: If you go to the TSP website and look at the returns (granted that all the funds were not actually available), average the best performing fund for each of the last 10 years and you get about 19.5%.

Use the "Projecting your account balance" calculator forsomeone at a high GS-11/mid GS-12 level say:$72,000/year salary, $45,000 in your TSP currently and 21 years to go before retirement and you get:






Average Return

Value at Retirement


10%

$1,337,119


11%

$1,566,762


12%

$1,841,018


13%

$2,168,987


14%

$2,561,680


15%

$3,032,412


16%

$3,597,300


17%

$4,275,857


18%

$5,091,714


19%

$6,073,502


20%

$7,255,920

Granted getting a 19.5% return every year is probably not realistic, but even the difference between 14% and 16% is more then a $1,000,000.00. In 2006 dollars this is still a difference of approximately half a million. That's a house!

The advice I was given: every little bit can make a huge difference.

[Mike]

If my work place is any indication, most federal employees are not high GS11 / mid GS12's. They are GS9's. So, rather than a $72,000 salary, you might want to adjust that down to $55,000. Next, those returns are unrealistic. In a single year, yes, there's a reasonable chance of achieving those gains. However, over the long term, it is very difficult. A more realistic range to look at would be 5-10%.

Of course there's also the issue of when you get what rate of return (otherwise known as volatility - and something the TSP calculator does not deal with - it just assumes the same percentage gain each year). Would you rather run off a string of 10% gains when your TSP balance is < $50,000, or would you rather see that type of action with a balance of $200,000?

[cowboy]

Mike wrote:
If my work place is any indication, most federal employees are not high GS11 / mid GS12's. They are GS9's. So, rather than a $72,000 salary, you might want to adjust that down to $55,000. Next, those returns are unrealistic. In a single year, yes, there's a reasonable chance of achieving those gains. However, over the long term, it is very difficult. A more realistic range to look at would be 5-10%.

Of course there's also the issue of when you get what rate of return (otherwise known as volatility - and something the TSP calculator does not deal with - it just assumes the same percentage gain each year). Would you rather run off a string of 10% gains when your TSP balance is < $50,000, or would you rather see that type of action with a balance of $200,000?



Nice post Mike! I wouldn't mind either at a 10% gain. I believe the key to it all is, if you can stick in early is to do it. When that high interest year hits you, it gains more. With family's to care for and other expenses this is hard to do early in life unless your single. There is manyfamiies that don't make even the $55,000 you mention a year and for many a good income comes late actually in life.

[Mike]

Yeah, $55k is still high. Maybe $40k-$45k is closer to the middle.

In any event, those with more than 20 years 'til retirement should focus moreso on accumulation / contributing as much as they can, while those on the other side of that should be paying closer attention to performance.

If you lose 20% of your TSP balance when it is $25k, that's a bit different than taking such a hit when the balance is $300k. :shock:

If I remember correctly when I ran the numbers, each percentage point in contribution will increase your final balance roughly 1/2 of what each percentage point gain in performance will get you... however, to achieve that higher performance, you must take on greater risk and subject yourself to all the potentially nasty surprises the market can dish out. This is precisely why the L funds were brought into play, so that one could walk the line between risk and volatility in a supposedly ideal fashion.

[Griffin]

The premise of the article was that contributions are more important then returns. While this is true initially, there is a point whereyourreturnsCAN exceedyour contributions.In fact: there is a point (near the end andthrough retirement) where your returns CAN meet your salary, if your in the game early and avoid the loses.

That is the golden ticket - a fund that can support you in retirement without dipping into the principle.

My pointin the last post isstrategy is AS important as contributions. While a few extra points in a good year are relativelysmall in a bull market (during thefirst 10 years)- a small positive return in a bear year can be life changing - on average! Good strategy is what is going to keep you from getting spanked in the bad years.

The key isto usethefirst five to ten years of your careerto get your family and householdestablished and use pay raises as an opportunity to increase yourcontributions until your at the max. Diverting the money before you get used to it is the easiest wayto avoid living to the means. An understanding and intelligent spouse will understand this if you give them the bigger picture (mine did, I guess I shouldn't speak for the rest).

The contributions will far exceed your returns for the first 10 years. This is the time to build up that solid 200K+ so that you can captilize seriously when the opportunity comes. When you consider that you only get afew good run ups every decade, it is critical to capitalize on those opportunitiesand all the volatility that goes with them. The differences can be substantial - the difference between a nursing home - or in home care.

The Risk in the TSP is very minimal, how diverisified do you really need to be? The diversity within the S fund or I fund is substantialand at any time you can go G or F. How many days do you ever get into a crash before word gets out that it'sa crash? Living in fear of the next crash becomes a hindrance - you just have to be willing to go G or F and stay there for months or years if necessary.When the big bearcomes, take a small loss early and wait - averages will eventually come back to you. In the long run, being aggressive will more then make up for the occassional drop unless you ride the stocks to the bottom. That is the only way your going to loose 20%. Many people rode the 99-00 crash to the bottom and that fear persists and is well founded, I don't disagree with that. But I am sure you will agree that you can not allow your emotions to dictate your actions.

[Mike]

Griffin wrote:

The premise of the article was that contributions are more important then returns. While this is true initially, there is a point whereyourreturnsCAN exceedyour contributions.In fact: there is a point (near the end andthrough retirement) where your returns CAN meet your salary, if your in the game early and avoid the loses.

By my calculations, it'll takeanotherseven years or sofor my TSP balance to hit the point where returns can realistically (i.e. with a 10% annual return)be expected to equal/surpass the amount of money going in (mine + matching). I ran a few scenarios on TSP's calculator to see what happens to a person earning $50k w/ 15% annual contributions and noticed the following:it would take roughly 18 years w/ 10% return to reach the point where returns = current salary (takes about 21 years if the contributions are cut to 10%). The timeframe grows to 30+ years w/ a 6% return though (no risk, no reward).

That is the golden ticket - a fund that can support you in retirement without dipping into the principle.

My pointin the last post isstrategy is AS important as contributions. While a few extra points in a good year are relativelysmall in a bull market (during thefirst 10 years)- a small positive return in a bear year can be life changing - on average! Good strategy is what is going to keep you from getting spanked in the bad years.

That really boils down to what your expectations are for your retirement. My cost of living now is higher than it will likely be in retirement, since I have a car payment, student loan payments, and a mortgage. None of these things will be there when I retire - and at the moment, they constitute the vast majority of my annual expenses. While I would certainly incur greater costs in retirement for leisurely things like traveling, I doubt that cost will ever equal present living expenses. Medical costs are certainly a wildcard, though (which is why I have an HSA :P).

The key isto usethefirst five to ten years of your careerto get your family and householdestablished and use pay raises as an opportunity to increase yourcontributions until your at the max. Diverting the money before you get used to it is the easiest wayto avoid living to the means. An understanding and intelligent spouse will understand this if you give them the bigger picture (mine did, I guess I shouldn't speak for the rest).

An alternative is to simply not get married and retain one's veto power over one's cash. :l Still, that is sound advice. I was plugging away at the maximum until about two months ago when I reduced the witholding to the amount needed to obtain matching (necessary to scrape up a reasonable down payment on the house). My miserly side has slowly returned, though - I've already bumped it back up to 6% in anticipation of the COLA, and I'll bump it up yet again later this year when my loan payments are reduced yet again. I hope to get it back to 15% in two years.

The contributions will far exceed your returns for the first 10 years. This is the time to build up that solid 200K+ so that you can captilize seriously when the opportunity comes. When you consider that you only get afew good run ups every decade, it is critical to capitalize on those opportunitiesand all the volatility that goes with them. The differences can be substantial - the difference between a nursing home - or in home care.

Remember, the idea is to reduce volatility while still being invested enough to catch those rides up... smooth out the chop so to speak.

The Risk in the TSP is very minimal, how diverisified do you really need to be?

That depends on what you're doing outside TSP. If you're > 10 years from retirement, you should have at least 2/3 of your money in equities... split between large caps, small caps, and international stocks. The rest should be in bonds, with perhaps another 5% or so thrown into REIT's / commodities. Doing so will guard against the inevitable downturns.

[Griffin]

Mike,

This thread is getting more complicated then my brain can handle, so I may get a bit sarcastic.

Your avoid-marriage advice is 6 years to late for me. I now operate under the premise “It’s cheaper to keep her”

I have a couple of friends my age (late thirties) who fit that classic permanent bachelor/bachelorette description. I have noticed that the stigma of “having never been married” has begun to creep up in their conversations fairly often in the past few years. Apparently, it is a red flag that can almost guarantees that future dates are going to be expensive, if at all. They all grudgingly admit that they regret their choice. Eitherway, It’s not the wives that will kill you (unless you periodically trade ‘em for a newer model) it’s the blood sucking rugrats…uh….I mean those darling children.

Here’s another long term strategy I intend to use: When my daughter gets a boyfriend I like, I’m going to tell her that I think he’s a jerk. With any luck, she’ll elope (money saved) leaving me to make amends by putting 20% down on their first house (money well spent).

Getting back on topic

I ran numbers based on 50K salary, 45K current in TSP, 21 years to go, 15% contribution (with 5% match) 10% return while working, 6% return in retirement, with a 70% pre retirement salary withdraw. I have included 2% salary increase annually (DoD has gone to NSPS which does away with the GS scale, I would not be surprised if the rest of the Fed follows suite eventually). I included an adjustment for 2% inflation (didn’t Bernake say this was his goal?). The model gets someone (near my age) well into their golden years without going broke.

I assume most people will need a minimum of 80% of your pre retirement salary to be comfortable (including investments and pensions, I am not banking on social security), 100% to maintain your standard of living. I think the Baby Boomers will prove this to be true – we’ll know in about 10 years. I have noticed that the older my wife and I get, the less we spend on fixed cost items like mortgages and cars (I expect these to be about 20% of our gross salary by retirement), and more on things like roofs, car repairs, toys and travel. God knows my wife’s tastes in everything are getting more expensive, although she emphatically denies it.

I also reduced my contributions at one point in order to buy a house. I went into it with the attitude that I was saving the money for a one-time major purchase and limited my home purchase to what I could afford without the extra cash. I cranked it back up, after close. I also took a TSP loan to make a needed addition to the house. However, I have decided that I will never dip into my TSP again, the money I lost in returns combined with the interest was more then the higher interest rate of a credit card.

I would like to average better then 10%, since I plan to retire to the Florida coast, buy a boat and finally get some peace and quiet. I will probably need more then 100%, but not enough to drive me into the next tax bracket. I can afford to be aggressive since I have a military reserve pension in addition to both of our full time pensions. That does give me a comfort level to take risks. I plan on smoothing out the chops by avoiding serious loses.

In my opinion, the best thing about TSP is the free IFT’s, this is it’s biggest advantage over a fidelity or similar 401K. I intend to play it aggressive until I get within five years of retirement. Most of your standard investment models are geared for people who don’t want to take the time to monitor it daily. I consider our pensions and her 401K to be our core safe investment.

Like you said, everybody’s situation is different.

[Mike]

That's precisely why you take a very close look at what your life will be like after retirement - everything gets turned on its head (particularly if you are moving to a ridiculously high demand housing area like Florida :eek: ). You don't commute anymore, so that drastically reduces the wear and tear on your car. You may have the mortgage paid off or are close to it - which eliminates a monthly payment that could be well over $1000. $12000 annually in after-tax money is not insignificant - it's probably 1/3 (or more!) of most people's take-home pay during their working years. :eek: Now if you're buying another house, that's different. Then again, you'd be selling the existing one, so a lot would depend on the price difference between the two.

On the other points - so, the friends are begrudgingly regretting their decision, eh... hmmm. That's unfortunate. If the women are cute, I might be able to help them. The guys are on their own, though. :D

I also don't see how anyone could have much of a problem in retirement if they're witholding 15% of their income for it... unless their habits change drastically. Social security will still be there for the baby boomers. The insolvency date is still years away... it's the rest of us that need to worry about that, since our payroll taxes are probably going to climb to push that date further away (at our expense). About all you can do is take charge of your own retirement plans and hope you won't need the SS money.

FWIW, I also took out a TSP loan for the down payment, but I made the loan term very short (< 3 years) to minimize the damage to my longterm gains... and I'm increasing my TSP contribution again to further offset that. I also continue to make the maximum contribution to my Roth each year. Of course the fear here is that of becoming too miserly and not enjoying life enough.