Many of us understand that one of the most important things that can be done for your finances is to save for retirement. Getting started early is one of the best ways to take advantage of compound interest and build a nest egg that can handle just about anything.
It’s important to consider how much you are setting aside because you might be surprised at how much it will cost you to live during retirement, especially if you factor in your health care costs.
One of the things that many people overlook as they save for retirement is the importance of including stocks in the portfolio. It can be difficult to feel confident about stocks in your retirement portfolio when you pay too much attention to the headlines and worry about when the next crash might come.
However, if you don’t use stocks in your retirement portfolio, you might not be able to retire when you want. Calculate My Wealth offers a look at what to expect if you are 25 years old, and you invest $200 per month until you are 65:
As you can see, using a savings account, or even just putting half your money in savings and half in stocks, you won’t come close to what you can accomplish with a large amount in stocks. Even if you back off a little bit to adjust your asset allocation to include more bonds as you approach retirement, you’ll be in better shape if you use stocks in your retirement planning.
Index Funds and ETFs to Reduce Your Risk
One of the biggest reasons that investors cite when it comes to avoiding stocks in a retirement portfolio is the risk. Many people worry about the risk involved when you use investments — especially when they have been through events like the crash in 2008 and 2009. However, the reality is that there are ways to reduce your risk.
Indexing can be one way to give your retirement portfolio a stock boost without taking on the risks that come with stock picking. Index funds are collections of securities that follow as specific stock index, such as the Russell 2000 or the S&P 500. There are even all-market index funds that offer exposure to every publicly traded security available. This means that, instead of worrying about whether or not you have picked the “right” stock, you have the advantage of the overall performance of a group of stocks. Over time, stocks tend to come out ahead, with the market not losing in any period of 25 years. So, even if the trend line looks volatile month-to-month, and even year-to-year, over decades it smooths out to show growth.
When you use index funds (or index ETFs) in your retirement portfolio, you don’t have to beat the market at all. You just have to ride the wave and perform as well as the market. When you combine this reality with long-term dollar-cost averaging for 20 to 40 years, you don’t have to worry about investing as much as you thought you would. If you start in your mid-20s, investing $200 a month consistently for the next four decades is likely to result in an adequate nest egg.
If you are older when you start, you need put in more. For example, using the retirement calculator at Calculate My Wealth again, you can see that starting at age 35, and putting in $400 doesn’t yield the same results if you want to retire at age 65. Even investing in all stocks can’t make up for the lost years of time.
Don’t let recent events and sensational headlines keep you from building wealth over time. You can probably afford to start investing now, and you need to make sure that stocks are a part of your retirement portfolio. If you want to limit your risk, try indexing — at least to start — in order to avoid the problems that come with stock picking.
Miranda is freelance journalist. She specializes in topics related to money, especially personal finance, small business, and investing. You can read more of my writing at Planting Money Seeds.