A financial advisor recently told me that the stock market is as risky as "gambling at a casino." He argued that you'd be better off shunning stocks and mutual funds in favor of market-linked CDs, equity-indexed annuities, and equity-linked life insurance. While I can't entirely agree with his concerns, there's some kernel of truth to them. The market can be volatile, and it has yielded long periods of lackluster returns. But unlike a spin at the roulette wheel, the stock market isn't a game.
Wall Street trades in shares of real, bricks-and-mortar companies, operated by flesh-and-blood human beings. For the most part, these enterprises sell actual products or services, generating revenue and, ideally, profit. And for every extra-risky, super-volatile small company in the market, there are sturdy, stable giants such as PepsiCo (NYSE: PEP) or National Grid (NYSE: NGG), which provide enduring products and vital services.
The "safer" path
As for the less risky investment vehicles the aforementioned advisor advocated, well, they're not all they're cracked up to be. Most will offer you just a portion of the stock market's advance. They often won't pass along dividend income to you from the stocks in the indexes they track. The income that some will generate for you will be taxed at your full income tax rate -- potentially quite a bit higher than the long-term capital gains rate of 15% for most folks. These investments can also tie up your money for long periods, giving you little flexibility.
Running the numbers
The kinds of returns these alternatives to stocks will give you may not help you retire the way you want to. Remember that the stock market has averaged about 10% annually over long periods, and that your average will likely be a bit different over your particular investing time frame. But investing in these "safer" options could leave you with a far smaller average return of 5% or less. That can have a huge impact on your final savings:
|
Average annual growth rate
|
$6,000 invested annually for 25 years becomes
|
|
3%
|
$225,300
|
|
5%
|
$300,700
|
|
8%
|
$473,700
|
|
10%
|
$649,100
|
|
12%
|
$896,000
|
|
15%
|
$1.47 million
|
|
25%
|
$7.91 million
|
Clearly, the growth rate matters. How much of a nest egg do you think you'll need to retire comfortably? According to our Rule Your Retirement newsletter, if you want your nest egg to last, aiming to withdraw about 4% of it annually (adjusting for inflation over time) is a smart move. To see what kind of nest egg you'll want, multiply your desired annual income by 25. Want $60,000? Aim for $1.5 million. Will $40,000 be enough? Then $1 million will suffice.
Clearly, many of the nest eggs in the table above won't provide many people with much in retirement. If you're among those staring at a puny expected nest egg, you don't have to settle for that. Many experts have agreed that you're often better off avoiding the sort of play-it-safe investments I mentioned above; instead, stick your long-term money in good stocks and mutual funds.
Better returns with limited risk
Fortunately, you can potentially boost the growth rate on your portfolio beyond that of "safer" investments without taking big risks on upstart companies that lack established track records. Solid dividend-paying stocks are one great way to combine current income with future growth. If a stock pays you a 3% yield, grows over time on top of that, and keeps increasing its dividends, it could be a highly effective way to build wealth. Check out these candidates for further research:
|
Company
|
Recent Yield
|
5-Year Average Dividend Growth Rate
|
|
BP (NYSE: BP)
|
5.7%
|
14%
|
|
Waste Management (NYSE: WM)
|
3.6%
|
10%
|
|
Total (NYSE: TOT)
|
5.2%
|
9%
|
|
Exelon (NYSE: EXC)
|
4.4%
|
11%
|
|
Maxim Integrated Products (NYSE: MXIM)
|
4.5%
|
20%
|
Data: Yahoo! Finance.
Dividends are never guaranteed, but some are darn reliable. And while there are situations in which market-linked CDs would pay greater short-term returns, the odds are good that such CDs will fall well short of what dividend stocks will earn in the future.
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