Risk – it’s a scary-sounding word, but one that’s unavoidable whenever you invest. But there are even bigger risks that come when you don’t save and invest for your future. The truth is that you face risks every day, however slight they may be, by simply stepping off the curb or getting behind the wheel of your car. You take these risks with an understanding of the rewards that you’ll receive – safely getting to the other side of the street or arriving at work on time.
The same is true when you invest – you accept the risks knowing that the returns you stand to potentially gain will make it all worthwhile. Or at least that’s how you ought to approach the process of building a portfolio. When the market is rising and falling every day, it’s easy to be intimidated by the thought of investing in stocks. In that case, simply keeping your money in the bank might seem like a reasonable alternative. If you leave stocks out of the picture, however, you run an even greater risk – the risk of not meeting your long-term financial goals.
It might sound odd, but having too much money in the bank isn’t always such a good thing. It certainly is a good idea to build up a cash cushion, enough money to carry you for a couple of months if you lose your job or can’t work. But you can’t count on cash savings if you want to maximize the returns towards your long-term financial goals for one primary reason – the eroding effect of inflation.
Over the past 75 years, inflation has grown at an average rate of around 3.1 percent a year. On the other hand, keeping your money in the bank would have given you an annual return of about 3.9 percent. After inflation, your money would have grown by less than 1 percent a year. That’s probably not what you had in mind when you started thinking about saving money for retirement, college for your kids, or any other long-term goal, particularly compared to the 10 to 11 percent returns you could have received from the stock market during that same period*. While keeping money in the bank might be considered "safe," it also doesn’t provide any significant return, either.
What might be worse than keeping your money in the bank, though, is to turn a blind eye to the uncertainties of the future. As companies increasingly shift away from providing comfortable pensions to retired employees, the responsibility for retirement planning must be shouldered by the workers themselves, with 401(k) accounts, IRAs, and other qualified plans. Today, if you don’t save and invest for your own future, chances are good that no one else will, either.
And if you’re counting on Social Security to bail you out when you retire, you’d better think twice. Social Security may still be around when you’re 65, but it’s quite possible that benefits paid out will be lower than they are today, and that you’ll have to be older before you can start collecting. The threat of being unprepared for your own retirement might be the biggest risk you need to face.
Does this all sound a little scary? Relax, you don’t need to panic – this is where a sensible investing plan and a long-term perspective come in. Time helps to mitigate the risks of investing in stocks, and when you invest a large portion of your long-term portfolio in the stock market, you can reduce the risks to levels that most investors find acceptable, at the same time generating satisfactory returns. And that’s nothing to be afraid of.
*Past performance is not a guarantee of future results. Investment experience will vary with stock selection and changing market conditions.