The Danger of Giving Up on Stocks

12/07/2010 12:07 pm EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

So you think you’ve learned your lesson from the stock market?

Well, if the lesson you learned was that stocks are dangerous, you have it all wrong. That’s the conclusion of a new study by T. Rowe Price, which shows that it pays to keep investing in the market, especially when things look most gloomy.

That advice runs directly counter to the actions many investors have taken recently. Since the market peaked in October 2007, more than $270 billion had fled from equity mutual funds. That’s not losses, it’s withdrawals.

As the T. Rowe Price report notes, “The bulk of the outflows occurred in 2008, before the S&P 500 Index skyrocketed 72% (from March 9, 2009, to April 23, 2010).

To put it clearly: Most investors sold at exactly the wrong time.

That’s only human nature, of course. Fear is a very powerful motivator. In fact, that’s how market bottoms are made—when everyone throws in their cards, unable to emotionally sustain more losses.

Perhaps a little historic perspective will help you hold your emotions in check next time you’re tempted to dump stocks in a panic. In fact, this latest report should encourage you to keep investing in a diversified portolio—even as you approach what you hope will be your retirement age.

The advice is especially pertinent for younger investors who have decided to stop contributing to their 40l(k) plans after watching their money melt away—or who have opted for the seemingly safest alternative of bonds. 

But don’t believe my cheerleading. Look at the facts.

Three Investors—Three Portfolios

T. Rowe Price constructed, and tested, three retirement portfolios for investors age 35, 45, and 55. Each planned to retire at age 65. Each portfolio gradually reduced the amount in equities until at age 65 the allocation became 55 percent in stocks, and 45 percent in bonds.

The 35-year-old investor started out with a 90% stock allocation and 10% bonds. The starting portfolio for the 45-year-old was 78% equities and the balance in bonds. The oldest investor, just 10 years from retirement, started with 67% stocks.

To make the analysis fair, the study applied results of all of the rolling 30-, 20-, and ten-year periods from 1950 through 2009. That included bull and bear markets, inflation, and recessions.  You can see the specific results and graphics at this link.

Stocks Beat Bonds

Bottom line: Owning stocks beats owning bonds—and beats inflation—over the long run.

That was true for all 30-year periods and all 20-year periods analyzed, and for eight out of ten ten-year periods.

Young investors with a 30-year time horizon had the best results. Their portfolio had a median analyzed return of 10% for all of those 30-year periods. The worst 30-year period returned 8.94%.  And every period beat inflation.

The middle investor had a positive median return of 9.8% on her stock portfolio—and all 20-year periods were positive. The 55-year -old’s portfolio showed the greatest volatility, but only one in five of those ten-year periods failed to beat inflation.

This study bears out the Ibbotson historical statistics which show that, going back to 1926, there has never been a 20-year period where you would have lost money in a diversified portfolio of large company American stocks, with dividends reinvested—even adjusted for inflation.

What to Do Now

As you move into the New Year, you’ll have the perfect opportunity to increase your retirement plan contributions—and to reallocate your future contributions as well as your current assets.

Don’t chicken out. History says that if you’re investing for the long run, you should be buying stocks on a regular basis. Even if your “long run” is only a ten-year time horizon. Remember, you won’t sell everything on the day you say goodbye to your job. Some of your money will have years to keep growing before you withdraw it.

Younger investors should be especially motivated. When the market is down, your regular dollar investment buys more shares. Then when the market takes off again—and it will, one day—you’ll have more shares, and more profits.

Still unconvinced? I remember a lot of people who felt the same way back in the early 1980s, in the midst of a terrible recession, high unemployment, and double-digit interest rates. They never thought the economy, or the stock market, would soar again. That was just before the Dow took off on its run from under 800 to over 10,000 in the next 20 years.

Don’t give up on stocks—or America. That’s the whole point of retirement investing—a belief that you’ll one day sit back and relax because you let your money work for you over the years.

Terry Savage is a registered investment adviser for stocks and commodities and writes a nationally syndicated personal finance column for the Chicago Sun-Times. She is the author of two best-selling books, The Savage Truth on Money, and The NEW Savage Number: How Much Money Do You REALLY Need to Retire?

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