When it comes to your TSP stocks, no use looking backward

If the 2023 stock market showed anything, it is that you cannot predict the stock market. Instead, you need a strategy you can stick with. To find out what the rear-view mirror is telling investors, the Federal Drive with Tom Temin spoke with Arthur Stein of Arthur Stein Financial.

Interview Transcript: 

Arthur Stein Last year was a very good year, and that was a welcome relief because 2022 was a historically bad year. I mean, not only were stocks down, but bonds were down, you know, double digit declines. And it was just, you know, was very unusual. It was two years in a row of bond declines, which almost never happens. It was the first time the TSP F fund and the stock funds had gone down in the same calendar year. And, you know, just looking at financial markets in general was the first time that anybody can remember maybe since the Great Depression or something like that. So, it’s pretty discouraging for investors. Then last year, there were a lot of ups and downs, but especially the last two, last two months of the year, everything really jumped. And we ended up the C fund was up 26%, the S fund 25%, the I fund 18%. And finally, the bond funds went up 5.6%, which is a good return for bond funds and outperformed the G fund for the first time in a long time. So, we finally saw what, you know investors are looking for. And it really benefited people who obviously stayed invested. So, if you were a TSP participant and became discouraged and either pulled out of the stock and the funds and the F fund, or whose, biweekly investments were not going into those funds, you really lost out. And actually, since the last two months of the year contained all the bond fund gains, all the fund gains, and a very large proportion of all the stock fund gains. You had to be in there for those two months especially.

Tom Temin It seems like people make the mistake of, you know, if they want a swing around their investments of taking what’s going on in the news and somehow overlaying that with what they think the market will do. And there’s been lots of bad news in the last quarter of 2023. The war in the Middle East, Ukraine situation droning on, the political paralysis in the United States. But the market doesn’t necessarily follow those things, which means you’re putting yourself in potential danger if you try to beat the market based on the news.

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Arthur Stein Absolutely. And one way to put it, Tom, is the economy is not the stock market, and the stock market is not the economy. And one of the reasons that’s true is that the stock market is what’s called a leading indicator. It tends to go down before the economy starts to decline, and it tends to go up before the economy starts to recover. And so, it makes it very hard to time the market based upon what’s going on now. And it’s one of the reasons why trying to time the market, trying to get in and out of the stock or bond funds based upon what you think is going to happen, has really been a losing proposition.

Tom Temin Right?

Arthur Stein The better strategy is just to decide what allocation you want between stock funds and bond funds, and then invest accordingly. And stick to that allocation.

Tom Temin Yeah, people that have great stories about how they beat the market or time this or that stock sometimes remind me of people who went to Las Vegas and came back, and they never tell you about the losses. They only tell you about how they could do no wrong at the crap tables or something. And you would think that you actually could have a chance of winning at the long term in Las Vegas, which nobody does.

Arthur Stein Yeah. And there’s actually an academic term for this. It’s called recency bias that we tend to think that that whatever has happened recently is going to happen in the future because it’s, you know, what we remember most closely.

Tom Temin We’re speaking with Art Stein, certified financial planner with Arthur Stein Financial in Bethesda, Maryland. And so, looking ahead to 2024, people are, you know, we’re here already and the same wars are going on. The same political paralysis is in the country. And so, you know, the underlying situation hasn’t changed because the calendar turned over. So, what are you advising people with respect to thinking about strategy for the coming year?

Arthur Stein Okay. Well, first of all, we have to remember that there is a lot of good news about the economy. Employment has remained very strong and interest rates have come down a little bit. Inflation has certainly come down. And, you know, economic growth has continued. So, our economy continues to do well. You know, the general forecast for last year was that there would clearly be a recession. I mean, that was just, you know, most people who forecasted, that’s what they were forecasting. And now I’m seeing the same forecast. So, the people will keep forecasting a recession and eventually they’re going to be correct. Maybe not this year. Maybe it’d be ten years from now, but. And then they will be crowned the king or queen of forecasting because they got it right. I think a key thing for people to do in the early part of the year, it’s a great time to review your financial situation and see where you are and whether you are on the right path. So of course, you want to look at your TSP allocation. With all the ups and downs. I mean, is the allocation what you want, and if not, you can rebalance. Employees, of course, want to look at the allocation of their biweekly investments, which, you know, can be very different than their current allocation. And one thing we often recommend is that your bi-weekly investments can be much more aggressive than your current allocation, because that you just have smaller amounts going in every two weeks. And if the markets go down, that’s good for you at that point because you are buying low. Then another question you need to ask yourself is, do you want to be in the Roth TSP, or do you want your money in a Roth IRA? You know the whole Roth question. So current participants, employees have the choice of their contributions going either into the regular TSP or a Roth TSP or the Roth TSP. And the major difference is that the money put in the regular TSP, whatever you put in reduces your taxable income by the same amount for that year. So, if you put in 10,000 in the TSP you’re going to reduce your taxable income $10,000. Now of course when you take that money out it’s fully taxable. With a Roth the money that you put in does not reduce your taxable income. But when you take it out there’s no tax on the withdrawals. So, you’re forgoing a tax deduction on a smaller amount for a tax-free withdrawal on hopefully a much larger amount in the future. One downside of that is that for employees, the reduction in because there’s no tax break on contributions, your taxable income is going to be higher. And you want to make sure that you can afford that. Now you can split up, you know, so that some of your contribution goes to the Roth and some to the regular. But people need to look at that. And there are a lot of advantages to a Roth account. For retirees they can decide to do what’s called a Roth conversion. So, they can take money out of an IRA and put it in a Roth IRA. And but then the amount they transfer is fully taxable at the time. That’s a much more difficult decision and requires a lot of planning. And it’s very whether it’s a good idea or not depends upon one’s personal situation.

Tom Temin Right. So, in deciding, though, Roth or regular TSP 401 K style, you have to understand, or you have to kind of have an anticipation of what your tax rate will be when you withdraw. Presuming that it’s going to be lower. And if you get some great private sector job where your salary triples, when you when you turn, you know, and you’re still working at the age of the minimum withdrawal, then you might have a higher tax than you would have if you’d done the Roth years earlier.

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Arthur Stein Absolutely. See the especially with the Roth conversion. You have to look at one how long do you think the money is going to be invested in the Roth? And, you know, if you’re. 85 years old on a Roth conversion makes less sense. And if you’re. A 35-year-old employee. And it also makes a difference how aggressively you’re investing. You know, if all the money’s going in the G fund, it really doesn’t make much of a difference. But if you’re an aggressive investor, you’re putting a lot of money into stocks, into the stock funds C, S and I and you expect those to grow very rapidly. Then it makes more sense. Now those are not the other variables. Another way to look at that is that if you think that your tax rates are going to be lower when you withdraw the money, then just in terms of doing the calculations, a Roth conversion doesn’t make as much sense. But we have to look at the fact that, you know, taxes may be higher in the future because we’re running huge deficits.

Tom Temin All right. So have a plan. Have a strategy. Don’t time the market and some eternal truths you might say.

Arthur Stein Yeah. Another thing to look at is life insurance. And I find many people are under-insured, especially if you are, for instance, married, you have kids, and only one spouse works. You need a lot of life insurance on that spouse. Like ten times salary is not too much. And for a healthy person, they need to compare what it costs for FEGLI, the federal government life insurance, group policy with what they can get in the private sector. And healthy feds are going to probably find that the private sector policies are cheaper and no reason not to get them. I would say that everyone should calculate their net worth every year. It’s value of everything you own, minus your debts. And that should be going up every year. Or if it’s not, it’s a real warning signal. Now, if you’re retired and you’re older. You don’t expect to see that increase in net worth. Perhaps. But it’s still nice if it happens. So, life insurance, calculate net worth. Again, an area where I see a lot of mistakes being made is in homeowner’s and auto insurance, because many people do not have enough liability insurance. And this is if you have an accident, you’re at fault, you get sued. Or if someone’s at your house. And they fall or slip, and they’re seriously injured, and they sue you. How much is your insurance actually going to cover. And what you’re going to find? Is that for most people it’s going to be somewhere around 100 to maybe $500,000. And so, think of it, you know, like you have someone over to your house, your kids have friends over. Some kid falls down the stairs. Can’t walk for the rest of her life. You could easily get sued and lose 1 million or $2 million lawsuit. And your homeowner’s insurance is going to say great we’ll cover that up to $250,000. And the rest of it that’s on you. Well, you don’t want to be in that situation. You want to look at what’s called umbrella liability insurance, which is sold in million-dollar increments. To cover that excess liability and home and auto. And one of the great things about umbrella liability insurance is it’s very cheap. Like I’d say, most people get $1 million covering auto and home of umbrella coverage for about six, $800 a year. Why not have the extra coverage for that? And then finally. Make sure you have emergency funds sufficient to cover you for two, three, four, five, six months of expenses, especially for FEDs who are working. But even for retirees. You know, if the government closes down, we could be in a situation again where salaries are not being paid and it even it would be pretty extreme. But, you know, maybe, annuities are not being paid either. And people should be prepared for that. So, beginning of the year, it’s a great time to review your situation, make some decisions and do that every year.

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