How does the TSP grow exactly?

[clanks]

Growing up listening to finance gurus, I always hear compounding interest. For simplicity sake, 5k turns into 10k, turns into 30k, turns into 100k, etc etc

However, I have been contributing to my TSP 20% of my base pay every month for the past almost 8 years. And I just broke 100k. I feel like there should have been more?

I was in an L fund for the first 5 or so years and now in a 70/30 C and S fund.

 

[theeyeofaneedle]

@clanks You're doing fine and likely have more saved than your enlisted peers

It's going to sit there for 30+ more years

 

[happyfrog]

@clanks A common misconception is the term "compound interest" in relation to stocks. Compound interest works on things you get interest on. I know that sounds obvious, but other than some dividends you get from owning certain stocks, they don't give you interest.

If a savings account gives you 10% interest (not realistic, but for explanation) and you have $1000 in the account. After a year you have $1100. Now that 10% applies to the 1100 and then you get $1210, then $1331, and so on.

Stocks earn you money by capital gains. Simply put, the stock is more valuable, price increases, and your capital increases. Your example of compounding interest is very generous, but in some cases, those sort of gains aren't unreasonable for stocks. So while the compound interest isn't going to get you much of anything in stocks, there is a very real chance your 100K in the TSP could be 150, 200, 300 or more by the time you end up needing it (presumably in 30+ years).

For what it's worth, it seems you're doing very well, and probably far ahead of most people you know.

 

[brianch35]

@happyfrog I think this answer gets to the point of your question the most. There are certain nuances in traditional retirement savings that are rarely mentioned but that make it so that plugging in the average annual S & P return into a compound interest calculator is usually an overestimate of how your portfolio will perform. The consequence of what the flying cyclist points out is that you do not have uninterrupted compounding interest….far from it. And volatility can really cut into gains. An easy example of this is if you invest $100 and achieve 100% gains in year one and 50% losses in year two, you will have an average annual return of 50% but still only have $100.

That being said if you leave the money in there until age 65 like everyone else is saying you will still probably do very well, but maybe just not as good as the glowing projections in the personal finance mainstream project.

 

[holywalk]

@brianch35 Your year over year return, though, is 0%, which is what everyone looks at. Slightly different than just the average yearly return.

You have to calculate it on your cost basis instead of just percentages.

 

[brianch35]

@holywalk Agreed, however I don’t think everyone looks at year on year. Dave Ramsey famously uses 12% for expected index fund returns based on average annual historical returns.

It takes a long time in the market to smooth out the effects of volatility. This can work for you or against you in the short term. These factors probably haven’t affected OP much since the past 8 years have been rip roaring for the market but generally speaking volatility and the misconception of uninterrupted compounding interest found in calculators and projections can mislead people.

 

[shineannette]

@brianch35 12% is essentially the unadjusted average returns over a long period of large cap stock (adjustments would mainly be for inflation). The trouble is that long period doesn’t start until 15 years after the initial investment and even then the average ranges widely from that number. It’s at 30 years where that average tends to be quite reliable/accurate.

 

[catherine_of_the_faith]

@brianch35 Agreed with what KcPilot says about year over year. But also in your example the average would be a 25% “average gain” (100% gain averaged with a 50% loss).

Regardless of the specific averages, it 100% comes back to the cost basis and the growth relative to that

 

[brianch35]

@catherine_of_the_faith Woops ya you right. I think we are all in agreement, I’m just saying the general public is often given projections and calculators that are overly rosy by finance guru types that don’t take some of the nuances of stock investing into consideration.

 

[catherine_of_the_faith]

@brianch35 Yeah you’re definitely right about that one!