There's a reason some people stay away from the stock market: Stocks are notoriously volatile. And if you load up on them in your 401(k) or IRA, you could see your account balance swing wildly from one week to the next or even from one day to the next. And that's a scary thing to witness.
But one thing you must realize is that while stocks may be volatile, they're also a solid growth instrument for your retirement savings. And if you play it too safe with your 401(k) or IRA investments, you could wind up substantially short on cash by the time your senior years roll around.
You need stocks in your retirement plan
Investing in stocks may be outside your comfort zone, but here's why it pays to do so anyway. The money you set aside for retirement today will gradually lose buying power over time. It's an age-old concept known as inflation, and no one is immune to it. Furthermore, Social Security, which will provide a portion of your retirement income, has done an historically poor job of helping seniors retain buying power in the face of inflation, which means your retirement plan needs to do an even better job to compensate.
What return should you aim for in your 401(k) or IRA? The stock market has historically delivered around an average annual 9% return, so if you go heavy on stocks in your retirement portfolio, leaving just a small portion in bonds when you're younger and gradually shifting toward more bonds as retirement nears, there's a good chance your investments will deliver an average annual 7% return.
Let's assume you're able to set aside $300 a month in your retirement plan over time. If you begin saving when you're 40 years away from leaving the workforce and snag that 7% return, you'll wind up with a total balance of $718,700.
But watch what happens if you decide to play it safe and stick mostly to bonds in your retirement plan. At that point, your investments may only give you a 4% average annual return, which means that saving $300 a month over 40 years will leave you with just $342,100. That's a far cry from $718,700.
Even if you're the type of person who doesn't have a particularly high risk tolerance, it pays to push yourself when it comes to your retirement plan. Remember, the money you save in your 401(k) or IRA is money you shouldn't be touching for years, and that gives you plenty of time to ride out the stock market's inevitable downturns and come out ahead.
Though bonds may be a more stable investment from year to year, you're not supposed to be touching your retirement savings from year to year -- you're supposed to be leaving that money alone until your time in the workforce is done. And while loading up on bonds makes sense once you're gearing up to actually retire, you need to focus on wealth-building during your working years -- and stocks are the best tool to help you achieve that.