I was talking to a friend recently who admitted that she has most of her retirement savings in bonds and cash. If she were in her 60s on the cusp of leaving the workforce, I'd say that's not an unreasonable allocation. But since she happens to be 42, I felt compelled to explain that her investment strategy was likely to leave her with a big savings shortfall.
Of course, the reason she invests the way she does is simple. She's afraid of the stock market. And she's not alone. But if you feel similarly, and you're letting nerves get in the way of meeting your retirement savings goals, you may be doing yourself a huge disservice.
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The hidden risk you may not realize you're taking
Many people shy away from the stock market because it's risky. Want to know what else is risky? Investing too conservatively during your wealth-building years.
Imagine you're able to contribute $300 a month to an IRA or 401(k) plan over a 35-year period. If you invest conservatively like my friend, you may be looking at a 4% yearly return -- and during some economic cycles, that 4% may even be generous. With that return, you're looking at a retirement account balance of about $265,000.
With a stock-heavy portfolio, you might easily score an 8% yearly return in your portfolio, and that's actually a touch below the market's average. Assuming that same $300 monthly contribution and 35-year savings window, you're looking at $620,000 instead .
If you don't want to do the math in your head, that's a difference of $355,000 in savings. And that's money you might sorely miss in retirement.
There are ways to mitigate the risks of owning stocks
If you're feeling skittish about investing in the stock market, there are steps you can take to reduce your risk. For one thing, make a plan to scale back on stocks in the years leading up to retirement to limit your exposure to the market when you might soon be dipping into your savings for income. Otherwise, recognize that when retirement is 10 years away or longer, there's lots of time to ride out downturns.
Also, make sure your portfolio is diversified. If you're not sure how to pull that off yourself, buy shares of an S&P 500 index fund or a total stock market fund. Both options give you broad exposure to many different companies without forcing you to choose stocks individually, which may fall outside your comfort zone.
My friend promises she's going to take my advice and move more of her savings into stocks in the near term. I hope she does. Even though she doesn't like risk, the risk of shying away from stocks could be much greater.
