If you’ve spent any time learning about investing and retirement and such, you’ve heard the term diversification. If you’re not familiar, when talking about investments, Merriam-Webster says that diversification means “to balance defensively by dividing funds between securities of different industries or of different classes.” In its simplest form, is usually means a strategy of having different investments at different levels of risk.
The general, generic advice given in our country is that you should have more exposure to risk when you are younger, then gradually move your investments into less volatile categories as you move closer to retirement. There are all sorts of “formulas” available, telling you what percentage of your assets should be in which groups, depending on your age and long-term goals. Imagine that your overall savings, investment and retirement plan is a tic-tac-toe board. When you are younger, and have more time until retirement, you should probably have most of your squares in a variety of higher reward, higher risk investments, such as stocks. Every decade in age, as you get closer to retirement, another square or two should move into less rewarding, safer investments so that you don’t risk losing all your money just before retirement.
If you are a military retiree, or plan to stay in the military long enough to collect retirement pay, your overall strategy differs from the rest of the world in a very big way. As a military-savvy financial planner told me, “You have to consider the fact that you already have a million dollar bond fund.” What he meant by this is that a military pension is very safe and stable, and it represents a large investment. My friend Doug Nordman, author of The Military Guide to Financial Independence and Retirement, did an excellent blog post detailing how and why a military retirement is so valuable. By his good math, a retirement check of $3,000 per month is worth well over a million dollars. For an average retiree in their late 30s or 40s, this means that you automatically have all this imaginary money in a very stable investment.
What does this mean for you? In order to be well diversified, you have to be risky. For most military retirees, their pension is the largest part of their overall investment/retirement portfolio. Military retirees already have a portfolio that is skewed towards the very safe. In order to achieve balance, you have to add some more aggressive, less secure parts. The details are up to you. If you have to chose between two TSP funds, and one is a little more aggressive, then knowing that you have a military retirement makes the more aggressive fund right for you.
What you do not want to do is put all the rest of your savings in equally safe investments. You will have relative safety, but you will miss out on the opportunity to grow your money, and that would be the opposite of diversification.
There is obviously much more to consider when building an overall investment and retirement plan. The implications of a military retirement change everything, and that is the important thing that I hope you take away from this post. After all, a “million dollar bond fund” is a lot of money, and you need to plan around it.
Thanks, Kate!
We use the interest rate on 30-year TIPS (when available) or I bonds to estimate how much principal we'd need to yield the amount of the annual pension. Between my pension and our Social Security estimates, it's a huge bond portfolio. We can put the majority of our remaining savings in equities and still be barely 40% stock/50% bond/10% cash.
Of course by "equities" I don't mean small cap telcom stocks. We invest in boring diversified index funds– some small-cap value, some large-cap dividend, a little large-cap growth, and some international value. We happen to be with Fidelity but the same can be done with two or three Vanguard index funds.
Personally the biggest challenge was having 8-10 years of service and being able to visualize staying for 20 years. I don't have an easy answer to that one yet…
Why would anybody who has served 20+ years in the military use any of their pension in stocks, equities, etc. in todays markets or the future markets?. That to me is the most stupid way to utilize what one has worked very hard to earn.
I know my self, while I was serving my 20 years, I was also saving about $1000 a month, so when I retired, I had/have a nice nest egg besides my monthly pension, as well as primary, and secondary homes paid in full and thats at a E-6 level. So don't be swayed by non rerirees trying to get your hard earned retirement. Dan Wojdyla U.S. Navy Ret.
Dan, I'm afraid I don't understand your comment. As you know, military retirees don't get to invest their military retirement pay the way that you can invest your other funds. Military retirement pay is stable, secure, and most importantly, cost-of-living adjusted. However, most people, like you, have assets beyond just their retirement paychecks. If you are trying to be diversified, it is important to include the value of your retired pay into the low-risk part of your portfolio. Otherwise, your attempts at balance will always be way, way off.
Congratulations on doing such a good job of saving and investing while you were on active duty, and thank you for your service.
Does'nt the article indicate to utilize ones military pension for further investment?. Why would I take my hard earned pension and think investing the big majority of it makes sense, its a gamble right?. So, I don;t see how you don't understand my comment. Most people I know that are miliary retired, use their pension for day to day expenses like taxes, mortgages, insurance, food, gas, utilities, with minimal amount going into savings. Maybe the Admirals and Generals could buy into your investment plan who are getting any where from $11k to 13K per month. My retired pay is $1600 per month.
Hmm, I might need to do some rewriting. I was talking about the money that you save while IN the military, like in TSP or IRAs. As I'm sure you know, retirement pay is rarely enough to fund all of your retirement. Service members need to be saving in other ways, including TSP, IRAS, and whatever other sort of investment vehicle they like. The message I was hoping to send was that you need to consider the safety of your military retirement when deciding how to invest your other money, or you won't be seeing the whole picture. For example, my husband has served over 20 years and therefore will receive a military retirement. His military retirement is no-to-low risk. It would make little sense for him to put his TSP savings into the TSP G fund, as it is a no risk, small gain fund. If he has only retirement and TSP, and he wanted to be diversified, he would need to put his TSP funds into something different. If you start adding in IRAs, or spouses retirement plans, or rental properties, keeping your overall plan balanced gets even more difficult. Remembering the large and safe value of military retirement is the first and most important step in getting the big picture right.
Thanks for pointing out that my piece isn't clear. I appreciate the feedback.
Now the way you state it now I agree with 100%. thanks for clairfying.