Smart investing includes knowing when not to max out your TSP

Terry Gerton You know, a lot of times we have been talking about TSP investments, and we’re assuming that people are making the maximum contributions, but that might not always be the right decision for folks depending on their circumstances. So let’s talk a little bit about how people should approach the level of investment that they’re considering for their TSP.

Art Stein Let’s look at it like I would use three different examples, somebody who’s within a year of retirement, somebody, who’s in the middle of their career, and then maybe someone who’s just started out, and understand that this is very much an individual decision. It’s a financial planning decision. What makes sense for one person won’t make sense for another person. But, when we do retirement plans, we have people who are within one or two years or even six months of retirement and want to know if they’re ready. And many times we see a situation where they’re maxing out their TSP contributions and maybe they have a TSP loan they haven’t paid off or credit card debt, or they don’t have enough auto and homeowners insurance, umbrella liability. Then we do recommend frequently, instead of maxing out your TSP contributions, make a 5% contribution going forward so that you’re building up your cash, you’re able to pay off any credit card debt that you have, and also, when you’re really close to retirement, many people are going to immediately start taking funds from their investments when they retire. So it’s not really such a good idea. It’s not a terrible idea. But why put all this extra money into the TSP when you’re just going to be taking it out very shortly? But as always, always put in at least the minimum 5% because the government’s going to give you a 5% match. All of a sudden, you’ve got a 10% contribution to go in.

Terry Gerton Well, there’s certainly going to be a lot of people in the coming months who are approaching that retirement date, whether they’ve been taking the early retirement or they’re separating from government service. So that’s a really timely consideration. What about the mid-career folks? What should they be thinking about?

Art Stein Well, mid-career folks, again, they want to look at whether they have emergency funds, the appropriate amount of insurance, and of course they don’t want to have any credit card debt. It’s okay to have a mortgage, even an auto loan, but if you have credit card debt, that’s a huge warning sign, and you want to pay that off as soon as you can. But except for that, I mean, it is great if they can max out their TSP contributions. And we would, in almost all cases, encourage that. What’s a much more difficult situation is for people who are lower income federal workers who may find it difficult to even do a 5% contribution and yet pay for all the expenses that they have. Then you have to look at the personal situation. For instance, if somebody is single, no dependents, life insurance is not a critical issue. If, on the other hand, you’re looking at someone who’s working, their spouse is not working, and they have two or three kids, life insurance is critical, absolutely critical. And we would want them to get the maximum amount of insurance that they might need. But also understand that for someone who’s healthy, outside term life insurance is probably going to be a better deal for them, more cost effective than what they can get from the TSP. Now, if they’re not so healthy, then the ability to avoid underwriting a health check before you get insurance, then they would rely on FEGLI, the Federal Government Life Insurance Program. So it just depends upon their situation. Of course, we would also encourage people to look at, where’s your money going? Keep track of your expenditures. Maybe say, I’m going to figure out how much I spent on different things the last six or 12 months, and maybe try and identify some other areas where you can save, because if you’re not making that 5% match to the TSP, you’re passing up the opportunity to immediately double your money.

Terry Gerton I’m speaking with Art Stein. He’s a certified financial planner with Arthur Stein Financial. So Art, let’s go back to that sort of basic budgeting. As you’re advising folks to lay out those expenses, and it could be for early careerists, it could the pre-retirement folks. What are some of the big factors that should go into that personal budgeting?

Art Stein Well, anything they spend money on. So, someone stops at Starbucks every day on their way to work, that’s an expenditure. And if they’re getting a $5 or $6 drink, that adds up. And it doesn’t seem like much maybe, but that could be $12, $1400 a year. And maybe you make coffee at home and take it to work with you, you get some go cups and avoid that. One area where I think people tend not to include in their expenditures, because I just noticed this, after many, many years in the business, that almost none of the people we dealt with when they listed their expenditures included pets, the cost of their pets. And the ability to spend money on your pets, the probability of spending a lot of money on your pets has gone way up because medical care for pets has become very sophisticated and expensive and people are getting cancer treatments and I’ve heard of brain surgery, all kinds of stuff for their pets. And that really adds up. Now, I’m not saying people shouldn’t do that. We just want people to be aware of where their money is going and think about it. It’s not a budget, it’s just a look at the historical expenditure pattern.

Terry Gerton And then certainly you’ve seen it all, I can imagine, but how would you advise people to balance these sort of real-time near-term expenses with the investment, the long-term strategy in TSP?

Art Stein That becomes much more difficult. I mean, we have to rely on the people’s good judgment because I have found that if I say to them, don’t spend money on your pet, well, that’s a no-go, you can’t afford to own a horse, that’s a no-go, I mean, they just don’t want to hear that, that means a lot to them. And of course, I mean I don’t think there’s an emotional connection to Starbucks, but there certainly is to a pet or a horse. But I want people to realize that those expenditures, if they’re not able to put at least 5% into the TSP, has consequences that can be very serious. And I would also say this, Terry, that if someone who is young, say they just started working for the federal government, which probably is not happening that often now, but hopefully will in the future. They are automatically enrolled in the TSP, and they automatically start withdrawing 5% from their paycheck to go into the TSP and one of the L funds, which I think is a great idea. It’s a great program. Of course, they don’t have to do that. They can say, I don’t want my money to go in there, I don’t want that much, I want it to go somewhere else. But what we found is that people, if it happened automatically, they tended to stick with it. If someone starts at a young age and they’re putting in 5%, they get the 5% match from the federal government, that’s a 10% contribution. If they did that for the rest of their life and they worked for the government for a long time and they invested appropriately, they would be in pretty good shape when they retired, depending upon a whole bunch of other things. I’m reluctant to say that because we do encourage people to put more in if they can. But the setting now is pretty good for people. As long as they can at least put in that 5%. That should be a major goal. And of course, starting early makes all the difference in the world.

Terry Gerton The miracles of compound interest.

Art Stein The miracles of compound interest.