Efforts to stem the coronavirus pandemic have caused the stock market to plummet, with the Dow Jones Industrial Average experiencing its worst first quarter in history and the S&P 500 closing out its worst quarter since 2008.
Many Americans have also seen their retirement savings take a nosedive over these last couple of months. For those who are still years away from retirement, this shouldn't be too much of a cause for concern. Historically, the market has always bounced back after a downturn, so given enough time your investments should recover as well.
This stock market crash is more concerning for those who are already retired or near retirement age. If you're depending on your savings to make ends meet in retirement, a strong blow like this could throw off your entire retirement plan.
But whether you're retired already or still have decades left before you can leave your job, there's one important lesson to take away from this market crash.
The key to weathering stock market storms
There's always risk involved when investing -- the stock market can be a roller-coaster with unpredictable highs and lows. However, if you want to build a nest egg that's robust enough to last through retirement, investing in the stock market is one of the best ways to achieve that goal.
The key to building wealth while avoiding as much risk as possible is to ensure your assets are allocated properly. Asset allocation refers to how, exactly, your investments are diversified. Younger investors will typically invest more heavily in stocks and less in bonds, because although stocks are riskier, they also see higher average rates of return. Because these young investors have plenty of time left to save, they can ride out these market crashes and see their savings bounce back before they retire.
As you get older, though, it's important to adjust your asset allocation so you're investing more in bonds and less in stocks. You never know when the market will crash, and if you're nearing retirement age and most of your money is invested in stocks, a market downturn could wreck your retirement plans.
How safe is too safe?
If you're risk-averse, you may be tempted to invest only in bonds or adjust your asset allocation toward bonds even when you're not close to retirement age. But keep in mind that although stocks are riskier, they still should have a place in your portfolio.
Despite the ups and downs, the stock market generally sees positive returns. Historically, the S&P 500 has seen average annual returns of around 10% since its inception in 1926. Bonds, on the other hand, may only see returns of around 4% to 6% per year. So although they're more protected against market downturns, you'll need to do a lot more of the legwork to accumulate enough cash to retire comfortably.
Even if you're close to retirement age, it's still a good idea to keep some money invested in stocks. You may not realize it, but you're still a long-term investor even when you're in your 60s. You'll likely spend at least a decade or two in retirement, and you'll want your investments to continue growing as much as possible during that time. While your portfolio should be weighted more toward bonds, keeping some money in stocks can help your investments grow faster.
When it comes to investing in the stock market, risk versus reward is a tricky balancing act. You want your savings to grow as much as possible, but you also want to protect your investments in case the stock market crashes. If this market crash has taught us anything, it's the importance of balancing investments properly to avoid getting caught off guard when the market is unpredictable.