By Gary Silverman, CFP®
This week, after a delay for the banking crisis, we continue our discussion on why stocks are an important part of a retirement investment portfolio. We’ve already determined:
1) You (or your spouse) may live a long time.
2) You’ll need more money every year to live comfortably.
3) In addition to needing to earn more each year, you must also be able to cover the taxes so you have enough left over to afford your cost of living.
But why stocks? Here I could dazzle you with numbers, charts, and graphs. But due to a lack of space and laziness, I’ll summarize most of it. And I’ll begin by instead answering the question, “why not stocks?”
After all, stocks can and do lose money. You think 2022 was bad? In late 2007 through early 2009, stock markets around the world lost more than 50% of their value. We also saw an entire decade of stocks (a long time by most people’s measures) that not only didn’t make a lot of money, but they didn’t make any money. During the same time period, bonds, the likely alternative to stocks, returned a whole lot more.
So, why in the world would you want any, let alone a significant portion, of your retirement savings in the stock market? It has to do with those conclusions we came to last week.
Living Long: Even though the stock market can be down for a decade, it’s never been down for two, let alone three. So, if you are 40 and planning on retiring at 65, your retirement savings has enough time to grow and get over pesky little things like 2022, the tech bubble burst, the credit crisis, or even the Great Depression.
If you are in your 70s, you may be around another 20 years. You have a significant portion of your future needs best served by stocks, even if the markets tumble early on.
In your 80s? Well, you might have another 10 years to go. And while there are certainly 10-year periods where the stock market is down, most often adding a small amount of stocks to your predominantly bond and cash portfolio gives a much better return without measurably raising volatility (risk).
Inflation and Taxes: Let’s use my longer-term averages where stocks return 9-10%, bonds 5-6%, and cash 3%. If inflation gets down to 3%, you effectively earn nothing on your cash investments. Bonds would generate an inflation-adjusted return of 3% and stocks would net you 6%. Earning double the inflation-adjusted rate of return is good for your portfolio. Add taxes to the equation, and stock returns are stellar compared to bonds. Just remember that they need time to grow.
Still, you shouldn’t jump in if you’re not doing so already. After all, you’ll be the one that must live with the results, good or bad. While it might make perfect sense for stocks to make up a part of your retirement investments—maybe even making up most of your holdings—you may not be able to hang on to them.
More on that next week.