The stock market can help you build large savings stacks in the long run.
Is the stock market good for you? Should you invest in something simple like the Dow Jones Industrial Average (^DJI 0.69%) today, or is it better to stick with dead-simple options such as savings accounts and certificates of deposit?
For sure, the stock market is prone to wild swings. Who can forget the crash of 2008, when the Dow dropped 50% in just 15 months? Or the dot-com bomb in 2000, which left investors with negative returns until 2006? Clearly, the stock market is not the place for money you might need in the next year or two.
However, the stock market still tends to treat investors right in the long run. Over the last decade (which includes the 2008 crash), the Dow has delivered average annual returns of 4.5% -- or 7.5% if you reinvested your Dow dividends along the way.
Meanwhile, the most generous savings accounts in the nation offer something like 0.95% annual interest yields. Certificates of deposit don't do much better, topping out at 1.5%. A Jumbo CD with a five-year commitment improves on that meager return, but still stops at 2.25%.
So the average Dow returns over the last decade absolutely crushed the best savings accounts or CD investments available today. How big of a difference do these percentages make in the long run?
Translating annual yields into 20-year returns
Let's say that you're looking at a 20-year savings timeline, putting your $100,000 nest egg away until it's time to retire. A 0.95% savings account would end up being worth $121,000 at the end of that span.
Using CDs instead, you'd be looking at $123,000 at the end of 20 years. A Jumbo CD, which requires a starting investment of at least $100,000, could net you $157,000 in 20 years.
A plain Dow tracker, such as the SPDR Dow Jones (DIA 0.69%) Diamonds ETF, would more than double your initial investment to $245,000, assuming that the next 20 years will be as rewarding as the last 10 years. Or, if you also reinvest your Diamond dividends in a DRIP-like plan, you'd more than quadruple your starting capital to $446,000.
The big payoff
Again, that's assuming the Dow stays at the average return of the last decade, which includes some of the worst annual returns in living memory. The dividend-adjusted Dow has gained 1,746% over the last 50 years for an average annual return of 16.2%. Revert to that long-term average, and you'd be sitting on $2.5 million at the end of 20 years.
There are no guarantees in the stock market, and the Dow may not jump back to those juicy 16% long-term annual returns. But even so, a 4.5% annual return could nearly double the best CD returns available today, or nearly triple the best CD yields if you take the time to start a dividend reinvestment plan.
Again, these returns don't even assume that you're beating the market. It's a simple Dow Jones-tracking investment, perhaps with the addition of a dividend reinvestment plan, and no need to actually pick stocks on your own.
If you absolutely need your nest egg intact in the next couple of years, the stock market and its potential for big price swings might not be your cup of tea. But if you have a decade or two to spare before heading into your golden years, it's really hard to beat the long-term returns of investing in the stocks market -- even if you're just staying with super-simple index trackers like the SPDR Diamonds.
