Table of Contents
Investing for retirement? Even as stocks are doing well—and they have been on an amazing run the last 5 years with 17 percent annualized gains—there always is a looming threat that the market’s bottom might fall like it did as stock values plummeted over 50 per cent from the market’s 2007 high to its 2009 trough. Therefore, it is understandable, particularly now as doubts soar about the bull market’s longevity, that you may ask yourself: Should I skip stocks altogether while investing for retirement?
However, if you are inclined to pass on stocks—or consider that choice—you must be alert to the downside of that choice. And, absolutely, there are significant drawbacks.
1. Investing for retirement?
In spite of their gut-wrenching volatility—or, perhaps more accurately, because of it—stocks usually produce higher returns than additional financial assets such as CDs, Treasury bills and bonds by a big margin over the long range. This superior performance is not guaranteed, yet it has been very persistent over the past century or longer.
These higher long-range gains provide a practical advantage as it will come to saving for retirement. For a given quantity of savings, you likely will wind up with a larger nest egg by investing in stocks than if you had shunned them. One additional way to look at this is that by investing in stocks it’s possible to build a big nest egg without needing to commit as much of your present income to savings.
Firstly, let us see how much you might need to save if you invest in, for example, a combination of 70 percent stocks and 30 percent bonds, nothing too racy for a 30-year-old who has 35 years until retirement. In order to have at least a 70 percent chance of retiring on 75 percent of your pre-retirement salary by age 65 from a mix of draws from your nest egg and Social Security payments, you’d need to set aside around 15 percent of your salary every year.
Therefore, how might you fare if you determine to skip stocks altogether and solely invest in bonds? If you stick to a 15 percent savings rate, the odds of having the ability to produce 75 percent of your pre-retirement income might dip to less than 20 percent. And that isn’t very comforting. It is possible to increase the odds in your favor by saving a bit more. However, to get your opportunity of producing 75 percent of pre-retirement income up to the 70 percent level, you’d need to save nearly 25 percent of your income every year. That is a standard the majority of people might have trouble meeting.
Plus, the percentage of salary you might need to save would be even greater if you determine to hunker down in cash equivalents such as CDs and money funds: right under 30 percent, or nearly 1/3 of your income.
Even if you had the perseverance and iron will to meet these types of hefty savings targets, diverting this much income from present spending to saving seriously could diminish the standard of living your family and you might enjoy within your career.
2. Consider risks
And just to be clear, I am not suggesting anybody should load up on stocks. That’d be foolish, particularly as you enter or get close to retiring, as a stock-market meltdown might derail your plans for retirement. In another post, I specifically warned against relying too much upon outsize returns (whether they are from stocks or any additional investment) to build up a nest egg. Wise investing cannot substitute diligent saving.
The point is that stocks ought to be a portion of your investing plan before and during retirement. Your savings percentage devoted to equities may vary depending upon factors such as your age, how upset you become as the market goes into a deep funk, as well as how much you are willing to entertain the notion of not having enough funds to comfortably retire or running short of money within retirement.
However, if, after considering all of the pros and cons, you determine stocks are not for you, that’s fine. You had better be ready to save your butt off during your career and especially keep tabs on withdrawals from the nest egg after retiring.
