With the market turmoil in 2008-2009, we have spoken to many investors younger than the age of 35 who are among the most risk averse. Many young investors saw their savings almost wiped out in a few months. Some have turned away from investing in the stock market in favor of so called “safe-haven” assets offering little or no returns. This is an unfortunate development since we believe equities offer the best potential to grow one’s portfolio. It is understandable that people might feel skeptical about investing in equities, but throughout history they have delivered the highest returns over the long term. However, high unemployment, a weak housing market, and inflation are all compounding to keep investor confidence low.
The statistics for younger investors are startling.
- A study from Merrill-Lynch found that over half of investors under 35 listed their risk tolerance level as low.
- According to a CNN-Money poll, only 22% of young investors feel that they should invest heavily in the stock market.
- MFS Investment Management’s Investing Sentiment Survey:
- “only 39% of Generation X and Y investors had a primary investing goal of growing assets” and those respondents “had only 34% of their investments in U.S. equities and kept 30% in cash.
- 22% of investors from the same survey indicate that their No. 1 goal is protecting principal or not losing money
- 61% report concerns over having to work past their planned retirement age.
- As a result of the 2008-2009 financial crisis, almost $11 trillion is resting within the banking system as of September 2010, according to the research firm Strategic Insight.
We understand how young investors with relatively little experience investing could be driven from equities. The Tech bubble and the recent financial meltdown are foremost in their memories. When the market began to drop in October of 2008, many investors pulled their money out of equities. By doing so, they sold on the way down guaranteeing their losses. Those that reentered the market bought on the way back up at rising prices, limiting gains. Long-term investors who rode out the storm kept the majority of their portfolio’s value. The aftermath is that many investors are now fearful of investing in equities and are choosing to invest elsewhere with less risk. In order to build a retirement portfolio that is capable of covering expenses in one’s golden years, it is necessary to save while young. The biggest impact on a portfolio can be made when the investor has a long horizon because of the compounding effects of interest. The longer you are in the market, the more you can compound your returns and grow your portfolio. Someone investing at age 25 has a 40-year investment horizon. Saving a little now makes a huge difference.
Using the historical average total return from 1926-2010 of 9.9%, $1,000 invested by a 25-year-old would be worth $43,642 when he reaches 65. A 40-year-old investor only has 25 years to invest and that same $1,000 would be worth only $10,591 dollars. This means that the 40-year-old will have to invest more each year in order to reach the same retirement goal.
By choosing low yielding, “safer” assets, many investors are missing out on the time where their contributions can grow their portfolio the most. Over the same 1926-2010 period, long-term government bonds had a compound annual total return of 5.5%—meaning the same $1,000 invested in long-term government bonds over 40 years would leave an investor with $8,513. If invested over 25 years, the total would be $3,813. The difference is enormous when compared to the return on equities.
Currently, many fixed-income securities offer extremely low yields that might not even beat inflation. This means that by investing a large portion of your portfolio there, you might actually lose purchasing power. This is why we strongly recommend investing in equities.
One strategy we recommend for younger investors building a portfolio is dollar cost averaging into the market. This is done by investing a fixed amount of money every month into the market regardless if the market is up or down. This eliminates an investor attempting to time the market. By buying a fixed dollar amount of equities every month, the ups and downs of the market are averaged over time. When the market is up, the investor buys fewer shares. When the market is down, the investor is capable of buying more shares. Over time as the market continues to rise, the share values rise and the portfolio is worth more. By buying when the market is down, greater returns can be realized.
Throughout the financial meltdown of 2008-2009, this strategy worked very well. For example, an investor that had been dollar cost averaging $100 per month in a Schwab S&P 500 index fund from October 2007 until June 2011 would have 256.7 shares of the mutual fund with a value of $5,327.58 and an annual return of approximately 9% at the end of the period without reinvesting dividends. This strategy beat the S&P 500 Index which lost approximately 4% annually over the same time period. Dollar cost averaging would have boosted this investor’s returns.
When investing in equities, we recommend investing in high quality, individual common stocks or mutual funds that invest in common stocks. Since young investors typically have less money to invest on a monthly basis, we would recommend high quality mutual funds that invest in common stocks and have a low management/fund fees. As the value of the portfolio grows, the investor can then choose to invest in individual, high quality common stocks. For more information regarding this topic, please contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
