Oppotunity Cost of TSP Loans During Bear Markets

[USGubmintGenEnginer]

What is the opportunity cost of taking out a loan using TSP?

Read the Things to consider before you borrow section here. It says "taking a loan could result in less money for you at retirement".

Others have written on this subject. One article may be found here, which is the source of the attached chart. However, in order to rely on any chart we must agree with the assumptions built into its calculations. After reviewing their assumptions we see that the chart is indeed useful as a decision guide to the passive investor, but only during periods when the TSP plan has funds (investment vehicles) whose returns can realisticly be expected to fulfill the assumptions. For active investors whose TSP returns outperform the C fund the opportunity cost of taking a TSP loan could actually be greater than as depicted on the chart, and the chart is useful as a decision guide during all market environments.

Opportunity cost is the amount of money one could have made with a certain dollar value invested but didn't because they already had this money invested, minus the amount of money they actually made on what their resources were invested in. There is no opportunity cost if you made more in your actual investment than you could have made by investing in the alternative.

If a passive investor who invests 100% of his/her TSP in the C fund had an account value of $100,000 on 6/30/2007 and opted to take a $30,000 loan @ 6.25% here is the opportunity cost calculation:

Account value, end of June 2007: $100,000.00
Actual Investment: $30K loan, 6.25% + $70K in C Fund
Part 1. 6/21/2008 Value of $70K $ 62,557.93
Part 2. 6/21/2008 Value of remittals: $ 6,148.10
Part 3. 6/21/2008 Loan balance: ~ $ 25,267.94
Account Value, less loan balance: $ 68,006.02
Account Value, with loan balance: ~ $ 94,073.97
Alternative Investment: No loan, $100K in C Fund
Account Value, June 21, 2008 $ 89,511.32


Therefore, if market conditions were changing and this person paid off their TSP loan today their account value would actually be higher, having taken the loan, than it would have been had they not taken the loan.

As we can see, the quantitative aspects of the loan decision depend upon the market environment applicable for the investment vehicles which are offered to the TSP participant. During bearish stock market periods it is not necessarily a bad idea for the passive investor to take a loan, but it would be advisable for loan-takers to be capable of paying it off without delay should market conditions change.


USGGE

 

[luv2read]

What is the opportunity cost of taking out a loan using TSP?

Read the Things to consider before you borrow section here. It says "taking a loan could result in less money for you at retirement".

Others have written on this subject. One article may be found here, which is the source of the attached chart. However, in order to rely on any chart we must agree with the assumptions built into its calculations. After reviewing their assumptions we see that the chart is indeed useful as a decision guide to the passive investor, but only during periods when the TSP plan has funds (investment vehicles) whose returns can realisticly be expected to fulfill the assumptions. For active investors whose TSP returns outperform the C fund the opportunity cost of taking a TSP loan could actually be greater than as depicted on the chart, and the chart is useful as a decision guide during all market environments.

Opportunity cost is the amount of money one could have made with a certain dollar value invested but didn't because they already had this money invested, minus the amount of money they actually made on what their resources were invested in. There is no opportunity cost if you made more in your actual investment than you could have made by investing in the alternative.

If a passive investor who invests 100% of his/her TSP in the C fund had an account value of $100,000 on 6/30/2007 and opted to take a $30,000 loan @ 6.25% here is the opportunity cost calculation:

Account value, end of June 2007: $100,000.00
Actual Investment: $30K loan, 6.25% + $70K in C Fund
Part 1. 6/21/2008 Value of $70K $ 62,557.93
Part 2. 6/21/2008 Value of remittals: $ 6,148.10
Part 3. 6/21/2008 Loan balance: ~ $ 25,267.94
Account Value, less loan balance: $ 68,006.02
Account Value, with loan balance: ~ $ 94,073.97
Alternative Investment: No loan, $100K in C Fund
Account Value, June 21, 2008 $ 89,511.32


Therefore, if market conditions were changing and this person paid off their TSP loan today their account value would actually be higher, having taken the loan, than it would have been had they not taken the loan.

As we can see, the quantitative aspects of the loan decision depend upon the market environment applicable for the investment vehicles which are offered to the TSP participant. During bearish stock market periods it is not necessarily a bad idea for the passive investor to take a loan, but it would be advisable for loan-takers to be capable of paying it off without delay should market conditions change.


USGGE

Isn't the loan interest the borrower pays IN the same as what G pays OUT at the time the loan is taken? If so, 6.25% is high, and the calculations are off. The borrower would actually be even better off?

 

[ChemEng]

Isn't the loan interest the borrower pays IN the same as what G pays OUT at the time the loan is taken? If so, 6.25% is high, and the calculations are off. The borrower would actually be even better off?

Agreed. Recently the loan rates have been less than 4%. If you feel that a long term bear market is coming, then a loan could be a wise choice *IF* you are putting the money in an appreciating asset.

 

[luv2read]

Agreed. Recently the loan rates have been less than 4%. If you feel that a long term bear market is coming, then a loan could be a wise choice *IF* you are putting the money in an appreciating asset.

Or use it to fund a Roth, IRA or other investment vehicle with a return > 4%.

 

[ChemEng]

Or use it to fund a Roth, IRA or other investment vehicle with a return > 4%.

The problem is that during an extended Bear market, you are going to have a hard time beating the risk free rate. If you could do that, then all you doing is raising the return required to break even. My earlier comments was thinking of using the TSP loan to invest in something like real estate.

 

[USGubmintGenEnginer]

I have never looked into taking a loan from TSP & really had no idea about the rate. The rates given were discussed in the article. Certainly last July would have been a good time for some B&H folks to take out a loan. I appreciate all the comments. Thought this might be of some value to each of us in some way. I'd have to be in a bind to take a loan because that takes away from the ability to respond to changing conditions on any given day.

USGGE

Agreed. Recently the loan rates have been less than 4%. If you feel that a long term bear market is coming, then a loan could be a wise choice *IF* you are putting the money in an appreciating asset.