(This article by Kimberly Lankford originally appeared in the March 2021 issue of Military Officer, a magazine available to all MOAA Premium and Life members. Learn more about the magazine here; learn more about joining MOAA here.)
To say that 2020 was financially challenging is an understatement. The stock market plummeted last February and March, millions of people lost their jobs, and everyone’s lives changed in unexpected ways. Even if you have the stability of a military career or guaranteed income from a pension, there was still plenty of volatility — fluctuating balances in your Thrift Savings Plan (TSP) and other investments, stop-move orders that led to unexpected expenses, or lost income when a spouse was laid off.
The uncertainty is especially stressful for people who plan to leave the military soon or those who are already retired.
But 2020 also illustrated the value of some key investing concepts that can help you weather difficult financial times. The following steps can help you prepare your finances no matter what happens next in the economy or the stock market, especially if you’re planning to retire soon.
Review Your Investments
It’s important to review your investing plans regularly, especially after such a turbulent year.
“Throughout the history of the stock market, there have been lots of periods of volatility, and there are some key principles and foundations that always apply,” said Capt. Gene Summerlin, USN (Ret), a certified financial planner with Edward Jones in Fairfax, Va., and a MOAA Life Member. “Why are you investing? What will this money be for? That can determine your strategy. Are you trying to grow your money or protect it?”
Even though the stock market dropped significantly in late February and March last year — when the Dow Jones Industrial Average and the S&P 500 lost more than 20% — both indexes gradually regained their value plus more over the rest of the year. The Dow Jones Industrial Average finished 2020 up 7.25% and the S&P 500 finished up 16.26%, both setting record highs.
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People who panicked and sold their investments during the downturn missed the opportunity to benefit from the rebound.
This volatility illustrates why you shouldn’t keep money you need soon in the stock market. But if you don’t need to tap that money for several years, then you can afford to ride the market’s ups and downs.
Even after you retire, you still have some long-term needs. If you shift all of your money to conservative investments, the value of your savings may not keep up with inflation over the 20 or 30 years of retirement.
“Proper allocation is the absolute key to maintaining a good portfolio and riding out the volatility,” Summerlin said. “We did a lot of hand holding in February and March, and we were very successful in keeping people on track.”
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Investing in a target-date fund, such as the Thrift Savings Plan’s L Fund, makes it easy to match your investments with your timeframe. You choose the fund based on the year you plan to start taking TSP withdrawals. The money is invested primarily in stock funds when you’re starting out, then gradually shifts into the fixed-income and government securities funds as you get closer to retirement. But even the L Income fund, designed for people who reached their target date and are taking TSP withdrawals, still keeps about 20% of its portfolio in stock funds.
Don’t Stop Investing for the Long Term
Psychologically, it can be tough to invest during a period of volatility, but investing during a down market can actually bring long-term opportunity, said Lt. Col. Shane Ostrom, USAF (Ret), CFP®, program director for finance and benefits at MOAA. One way to do this is through dollar-cost averaging, where you invest a fixed amount of money on a regular basis, through your TSP or 401(k). You’ll buy more shares when prices are low — and end up with more money when the value rises.
“To me, market volatility is a plus,” Ostrom said.
This strategy paid off for people who kept investing during the 2008 downturn, which was “gut-wrenching at the time” but paid off with long-term gains.
“If people are savvy and are dollar-cost averaging and understand that in the long haul markets are always up, they love volatility and down markets,” he said.
Investing automatically can also help you avoid panicking and selling at the wrong time — or waiting too long and missing out on opportunities.
“Dollar-cost averaging can help take the emotion out of that investing,” said Shay Cook, financial readiness manager with the FINRA Investor Education Foundation. “It compels you to continue to invest the same amount regardless of the market’s fluctuations, and to avoid the temptation of trying to time the market.”
Take Advantage of Tax Breaks for Saving
Tax breaks and matching contributions can help stretch your retirement savings, no matter what happens in the stock market.
If you’re in the Blended Retirement System, try to invest at least 5% of your pay in your TSP to get the Department of Defense’s full match — that’s free money.
You can contribute up to $19,500 to your TSP in 2021 (or $26,000 if you’re 50 or older). You can either make pre-tax contributions, reducing your taxable income now but paying taxes on the withdrawals, or you can make Roth TSP contributions, which don’t provide a tax break now but can be withdrawn tax-free in retirement.
If most of your money is in tax-deferred savings and you expect your tax rate to rise, consider making new contributions to the Roth.
“Usually taxes have no place to go but up when they’re already low like they are now,” Ostrom said.
If you’re deployed to a combat zone and receive tax-free income, you can contribute up to $58,000 to a TSP in 2021. Those contributions go in and come out tax free.
You can also contribute up to $6,000 to a traditional or Roth IRA in 2021 (or $7,000 if you’re 50 or older). You can contribute the full amount to a Roth IRA if your modified adjusted gross income is less than $125,000 if single or $198,000 if married filing jointly.
You can withdraw Roth IRA earnings tax-free after age 59½ (if you’ve had a Roth for at least five years), and you can take the contributions at any time without penalties or taxes.
Build Up Your Emergency Fund
“The pandemic has showed us the need for an emergency fund — we want to be prepared for an inevitable disaster,” said Lt. Col. Josh Andrews, USAF (Ret), director of military life advice for USAA. This money can help you pay the bills if you or your spouse lose your job, cover emergency home and car repairs, or pay extra child care costs when schools are virtual.
“If you’re a two-income family, three months of living expenses is probably sufficient,” said Summerlin. “But if you’re only a one-income family, you probably need six months of living expenses set aside.”
This money needs to be in a safe and accessible account — such as a savings account with a bank or credit union — even if it’s earning very little interest.
“Emergency money isn’t designed to make you money,” Ostrom said. “It’s designed to be liquid and safe and available when you need it.”
Pay Down High-Interest Debt
You’ll have more money to reach your other goals when you’re not spending as much in interest. Paying down a credit card with a rate of 18% is like earning a guaranteed 18% return on your investments.
“I look at debt as a giant sucking hole,” Ostrom said. “Debt takes away from income you could be using for more productive things.”
Andrews recommends paying down high-interest debt right after setting aside some money in an emergency fund.
“Once you get $1,000 in an emergency fund, then look at attacking that debt,” he said. “Review your budget to find ways to reduce your expenses, and maybe look for ways to earn extra money — get a second job, clear out your closets, anything you can do to free up money and also reduce the interest you’re paying.”
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Paying down high-interest debt can have a ripple effect.
“If you pay that down, it can save you money in the long run, and you can set that money to pay off the next one and roll that down,” Cook said. She recently paid off her car, and immediately diverted the money she had been spending on car payments into her savings.
You don’t need to rush to pay off a low-interest mortgage, but you may be able to save money by refinancing. Andrews cut his mortgage rate from 6.5% to 3.75% when he refinanced a few years ago, and he refinanced again in October, with a VA interest rate reduction loan of 2.375%.
“For us, it freed up $250 per month, which means that now I can repurpose that money towards other goals if I need to, such as paying down other debt or putting more towards the mortgage and paying it off quicker,” he said.
Closing costs for refinancing can be 2% to 3% of the loan’s value, so you need to calculate whether you’ll be in the house long enough to make those costs worthwhile.
Prepare for Extra Expenses Before You Leave the Military
If you plan to leave the military and transition to a civilian job, be prepared for less job stability and new expenses, such as health insurance premiums and no tax-free housing allowance.
“I encourage those in this position to really focus on and understand their cash flow, both now and after their transition,” said Capt. Ted Digges, USN (Ret), executive director of the Penn Mutual Center for Veterans Affairs at the American College of Financial Services.
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Andrews recommends having six to 12 months of expenses in a transition fund — in addition to your emergency fund — if you plan to leave the military soon, which can help if you have a delay in starting a civilian job or extra moving expenses.
When you leave the military, your income may be more at risk during an economic downturn.
“Learn from the difficulties that others are going through and plan for it with the emergency fund, reducing debt, and reducing expenses,” Andrews said.
If you have to retire unexpectedly, taking a part-time job, downsizing, or moving to a less expensive area can also help.
Build Up Your Retirement Cushion
Volatility can be even more stressful after you retire. If you receive military retirement pay, you can appreciate that guaranteed paycheck during an uncertain time. But you may also be withdrawing some money from your retirement savings. It’s important to set aside extra cash in a safe account to cover the gap between your expenses and your guaranteed income — in addition to your emergency fund.
Ostrom recommends that retirees keep two to three years’ worth of those expenses in a savings account.
“Then you know you’re covered for two to three years and you’ll also have some investments in a portfolio that has some growth portion to it, because you’re going to live a long time and you have to stay ahead of taxes and inflation,” he said.
That strategy helped retirees make it through the challenges of 2020.
“This past year was pretty remarkable. We had such a significant decline in the market, but it turned around quickly,” Summerlin said. “A couple of my clients had cash set aside, and instead of liquidating mutual funds, we drew down the cash for about four or five months, and in another case they reduced their expenses pretty significantly. We tried to leave that portfolio alone so it can heal.”
Kimberly Lankford is a freelance financial writer and military spouse from Lynchburg, Va.
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