Which is better – $100 or $600? This is pretty black and white, of course $600 is better.
Would you prefer to have your paycheck reduced by $100 or $600? Again, there is little question. If your paycheck is to be reduced, the least amount possible is best.
Yet, nearly half of Americans are making exactly the opposite choice. In a recent Gallup Poll, it was found that the level of stock ownership in the U.S. is at record lows. Only 52 percent of Americans have investments in the stock markets. That is down from the peak in 2007 when nearly two in three held stocks.
The age group whose stock ownership has dropped the most is not the one that you might think. It would seem logical for older Americans to reduce their stock ownership, given that many are approaching or at the point where they are living off of their savings and therefore need a more conservative investment approach. Yet while stock ownership among those 55 and older is down by about 9 percent since 2007, the age group whose participation in the stock market has dropped the most is the 18 to 35 group. Just over half in the 18 to 35 age group reported holding stocks in 2007, and now only 38 percent hold them.
The Great Recession and the dramatic stock market losses of 2008 and early 2009 certainly left a mark on the psyche of investors. The lack of job security and uncertainty about the economy are also good explanations for the low level of enthusiasm for the stock markets since then. But avoiding the stock market, particularly for those younger than 35, is the equivalent of trading $600 for $100, or worse.
Since 1928, the average annualized return on the S&P 500 has been 9.50 percent. For the last ten years, through the end of 2015, the average annualized return has been 7.25 percent. In both cases, the stock market return is over six percent more than the return to be had on safe short term investments, such as three month U.S. Treasury Bills. Over the last ten years, the stock market return has been six times the return on T-Bills.
For young people saving for their distant retirement, the cost of sticking with safe investments is huge. Staying safe means that you will have to save six times what you would have to save if you were to invest in the stock market in order have a secure financial future. Alternatively, you will have to be willing to live on one sixth as much money when you do retire.
Yes the stock market goes down. Generally speaking it goes down one in every four years. However, it has never failed to recover. If your investment horizon is thirty years or more, you have nothing to fear from a short term decline in the value of stocks. In fact, a short term decline is an excellent time to add even more to your stock investments. Some analysts predict that future stock market returns will not be as good as in prior years. That may well be the case, however the returns are still likely to be better than T-Bill returns over long periods.
I get it. It is hard to see your savings balances go down. When I know the stock market is down, I tend to not look at my portfolio, being the buy and hold investor that I am. How can I get away with that, especially now that we’re living off our investments? I have arranged our investments so that our short term cash flow needs are met with safe investments, leaving only money that we will need ten or more years in the future in stocks.
A good approach to arranging your holdings for a good night’s sleep is to use a time based bucketing approach like this. Have your emergency fund and any money that you will need to spend in the next year, such as for big ticket purchases, property taxes or college tuition in safe cash like investments, like a money market mutual fund or a savings account. Money that you will definitely need within three years, should be invested in short term bonds or a short term bond mutual fund, which pay higher interest than money market funds. These investments can fluctuate in value, but generally the fluctuations are limited. Money that you will need in the next three to ten years should be invested in what are called intermediate bond funds or bonds maturing in three to ten years. The expected price fluctuations of these mid range fixed income investments is larger than short term bonds, but the higher income and longer horizon provide a cushion for these fluctuations. Finally money that you won’t need within ten years can reasonably be invested in the stock market.
If you are 35 years old, and plan on leaving the work force at the current full retirement age of 67, there is no reason that your investments for retirement shouldn’t be in the stock market. Over such a long horizon your investments will grow at a faster pace than they will with a simple interest bearing account. To make the most of your savings you need the leverage the stock market provides. The alternative is to save every dollar you will need, which will have a big impact on either your current or your future lifestyle.