Between soaring inflation and stock market losses, it’s no surprise that some people are a little hesitant to lock their money away in a retirement account right now. After all, you usually can’t access your retirement funds under 59 1/2 without penalty, and there’s no guarantee your investments won’t take another dip.
But if you’re still decades away from retirement, the stock market is probably the best option for your retirement savings. Here’s why.
It’s all about the long term
It is disheartening to invest your hard earned money only to see those investments lose money. Many people have faced this lately. But experienced investors understand that these short-term declines are often just that – short-term.
If you’ve invested in strong, stable businesses, you’ll likely get your money back and more. But it can take several years to do so. That’s why you should generally only invest money that you don’t plan to spend for at least five to seven years. With no pressing need, you can wait to withdraw the funds until you are ready.
Investing is pretty much the only way to beat inflation and increase your long-term purchasing power. While you can grow your money without risk of loss with a savings account or certificate of deposit (CD), it’s quite possible that the rate of inflation will rise faster, especially in years like this. So while you’re growing your wealth, your money won’t go as far in the future, because you’ll have to spend more each year to afford the same standard of living.
With investing there will probably be a few years where you will lose money – but over a few decades there will still be many years where you will earn handsome returns. The S&P 500 index, for example, has a compound average annual growth rate of 10.7% over the past 30 years. This means that if you average all the wins and losses from each year, you will get a gain of 10.7% each year. And this despite losses of up to 37% in some years.
If you invested only $100 a month in a retirement account and it grew by 10.7% each year, you would end up with over $238,000 after 30 years, even if you didn’t contribute than $36,000 of your own money. There is no bank account that can give you that kind of return.
But older people may want to be more conservative
Sticking to a stock-heavy portfolio, even during periods of market volatility, is wise if you’re far from retirement, as you have plenty of time to bounce back from losses. But the same is not true for those approaching retirement. They may want to take a more conservative approach.
As you age, you generally want to shift your money from riskier but potentially more rewarding stocks to safer investments, like bonds. These may offer lower returns, but there is less risk of losing money on the brink of retirement. A good rule of thumb is to keep 110 minus your stock age. So if you’re 60 it would be 50%, and if you’re 70 it would be 40%.
You can also keep some of your savings in cash if you plan to spend it soon. In that case, consider opening a high-yield savings account. These offer higher annual percentage returns (APY) than physical savings accounts, so your money grows a little faster.
No one can predict the best time to invest or withdraw your money from the stock market, so we just have to make our best guess based on our goals and when we plan to use the money. If time is on your side, don’t let recent performances get you too down. Focus on the long-term growth potential of your investments and resist the temptation to make drastic changes to your portfolio.