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For Retirement Security, Dip Into Stock Market

Oct. 26, 2015
For Retirement Security, Dip Into the Stock Market
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Would you rather die or invest in the stock market?

Shock value aside, it’s a valid question: In a Nationwide Financial poll, more people said they fear investing than public speaking, job loss and, yes, death.

That fear has many people missing out on returns because they keep too much of their saved money in cash, according to a State Street study. It found that Americans as a whole have a 36% cash allocation (bank accounts and term deposits such as CDs). For millennials it’s a striking 40%. This too-conservative approach could easily cancel out the benefit of a small uptick in how much Americans are saving overall.

For most people, a comfortable retirement is out of reach without a diversified portfolio that includes a reasonable exposure to higher-risk areas such as stocks.

Investing protects against inflation

Most people fear stock trading because they’re worried about potential losses. But while that’s a valid concern — and a fresh wound for those whose investment accounts took a hit during the recession — there’s also substantial risk in not investing, says Danna Jacobs, a certified financial planner with Legacy Care Wealth in New Jersey. One of those risks is inflation.

“Today, $100 might buy you a nice dinner out. But 30 years down the road, that same $100 won’t get you that same dinner. At the very least, you want to make sure you’re not losing money” through reduced purchasing power, Jacobs says. “While we don’t really see the impact of inflation year over year, we do see it over an extended period of time.”

Start off slowly, do your research

Parking your long-term savings in a bank account means your nest egg won’t keep up with inflation. And you’re likely already in the market (just not making the stock decisions) with a 401(k) or IRA. But what if you want to round out your market approach?

The typical investor does just fine by making regular contributions (that’s called dollar-cost averaging) to index funds. Those funds track an index, such as the S&P 500. For example, the Vanguard 500 Index Fund buys stock in 500 of the largest U.S. companies, letting its investors own small pieces of all of them — without the high commissions and greater risks that come with frequent trading.

There is some research and legwork that goes into selecting an index fund. You’ll want to look at expense ratios, which show how much you’re paying for the investment. And make sure you’re allocating your assets to suit your age and the amount of risk you can tolerate. But once you’ve selected your investments, it’s just a matter of rebalancing when things shift out of line over time.

If that sounds like something you don’t want to take on, a new crop of online advisors called robo-advisors can manage your portfolio for you — including, in some cases, an IRA or even a 401(k) — for an annual management fee that is generally less than 0.5% of your account’s value.

Your money should be put to work

Most people wouldn’t pass up a chance at an easy income, and that’s what investing provides: You earn money and put it into a diversified portfolio, then the market does the rest of the work for you.

That’s because of compound interest: As your money earns a return, it builds a bigger balance, and that bigger balance then leads to bigger future returns. The effect intensifies over time, which is why the earlier you start saving for retirement, the less you have to save overall. (See our compound interest calculator.)

“The benefit of compounding returns is incredible,” Jacobs says. “You can really change your long-term wealth picture in a way you can’t do unless you invest. Any other way we get returns is by us working really hard, through either increasing our income or decreasing our expenses.”

If you invest wisely, you may not have to do either of those things. Say your retirement goal is $1 million. You could reach it in 40 years by putting away $1,700 a month at a 1% return (like savings accounts provide).  Or you could invest just $400 a month at a 7% annual return (like the stock markets historically provide) over the same period.

Even big losses bounce back

For the stock market, time really does heal all wounds. If you do experience turbulence (Spoiler alert: It’s bound to happen), history tells us that losses aren’t permanent — unless you panic and sell.

According to data from Fidelity, investors who stayed the course from September 2008 to March 2010 saw an average increase in account balance of more than 20%, despite market turbulence. Those who pulled out at the end of 2008 or the beginning of 2009 and stood on the sidelines through March 2010 lost an average of nearly 7%.

Use investing for long-term goals

Of course, not all of your money should be invested. Money you need in the short term (within five years), such as an emergency fund or a down payment on a home, shouldn’t be in the market, Jacobs says.

You do want to invest long-term savings, for retirement and goals that pass that five-year threshold. For those goals, Jacobs says: “It’s OK if your money fluctuates, because this is not money you need in the near term. You’re invested for the long term, and you know that all of your short-term needs are met.”

That alone can help you stomach the market.

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Arielle O’Shea is a staff writer at NerdWallet, a personal finance website. Email: Twitter: @arioshea.

Image via iStock.