As you're preparing for retirement, there are countless decisions you'll make along the way. Although each individual choice may not seem significant in the moment, they build on each other over time and can have an enormous impact on your retirement.
There's one choice in particular that may seem wise on the surface, but can cost you in the long run -- potentially more than $1.5 million.
Balancing risk and reward when investing
One of the key factors to consider when investing is how aggressive or conservative your strategy should be. Common sense says to play it safer to protect your savings, but sometimes being too conservative can be an incredibly expensive mistake.
When you invest conservatively, you might choose to invest primarily in bonds rather than stocks. Especially when the stock market is volatile, it can be tempting to throw all your money behind conservative investments and avoid stocks entirely.
On average, however, stocks outperform bonds over time. Over the last century, large stocks have seen annual returns of around 10% per year on average. Long-term government bonds, on the other hand, have experienced returns of just 5% to 6% per year.
While that may not seem like a significant difference, earning a 10% annual return on your investments versus a 5% annual return can potentially amount to an extra $1.5 million in savings by the time you retire.
How to boost your savings by $1.5 million
The median earnings figure in the U.S. is approximately $48,000 per year, according to the Bureau of Labor Statistics. Say you're contributing 10% of your salary to your retirement fund, or $4,800 per year.
If you were earning a 5% annual rate of return on your investments, that $4,800 per year would amount to approximately $580,000 after 40 years. However, if you were earning a 10% annual return, all other factors remaining the same, you'd have roughly $2.124 million saved -- which is a difference of $1.544 million.
Of course, it's very likely you won't see the same rate of return year after year for decades. However, if you're consistently investing conservatively, your savings won't grow nearly as much as if you're consistently investing more aggressively.
What about stock market downturns?
One of the primary reasons investors may shy away from investing aggressively is because they're concerned about market crashes wiping out their savings.
It's important to note that as you get closer to retirement, you should be shifting to a more conservative strategy. If you're in your 60s with all your money invested in stocks, your savings won't have much time to recover from a market downturn -- which could be a problem if you're going to need that money soon.
However, when you still have decades until retirement, market downturns shouldn't be as concerning. Your savings may take a hit in the short-term, but they have plenty of time to bounce back. And despite being a rollercoaster of ups and downs, stocks still see higher rates of return over time than bonds.
While stocks may be more volatile than bonds, they also experience faster growth. If you're investing conservatively because you're worried about market downturns, you could reduce your risk. However, you could also miss out on thousands or even millions of dollars in potential savings.