Every American wants to retire comfortably, but there are countless ways to accomplish that goal. On paper, retiring in style looks as easy as one, two, three -- save money, invest it, and reap the rewards. Simple, right?
Unfortunately, it's rarely that simple. Unexpected expenses and that thing we call "life" often turn our straight road to retirement into a winding one full of speed bumps and hazards. You might buy a home, change jobs, get married, have kids, send those kids to college, or experience a death in the family. Life-altering events like these can affect your cash flow and your resolve to keep your retirement planning on track.
Stock market tips for retirement planning
One of the most critical steps in saving up your "retirement number" is investing in the stock market. It may not be the first investment vehicle workers or pre-retirees turn to, considering the nearly 55% drop the Dow Jones Industrial Average suffered between 2007 and 2009. However, over the long run, the stock market has significantly outperformed inflation, as well as other investment tools such as CDs, money market accounts, bonds, and precious metals like gold.
That said, here are a few important stock market tips for retirement planning that you should implement in order to keep your retirement on track.
1. Accept that the stock market moves in both directions
Even though the stock market has been proven to be one of the best wealth-creators on the planet, it doesn't move in a straight line. Recessions are a natural part of the economic cycle, and it's important for investors to dissociate their emotions from their investing decisions. In markets both good and bad, our instincts and emotions can be our worst enemy. Take the financial crisis of 2008-2009 as an example: Investors who panicked and sold at the market's lows realized huge losses, while those who held on to their investments and weathered the storm have since enjoyed several years of gains.
As an investor, you can't control where the stock market heads next. Accepting this fact is the first step on the path to a financially secure retirement.
2. Think long-term
The stock market works best for investors who hold companies over the long term. It's impossible to predict stock market tops and bottoms with any consistency, even if you have moments of success from time to time. Just missing out on a handful of the stock market's most robust gains can cost you dearly over the course of decades.
According to data from Edward Jones, if you had stayed invested for the full 10-year period from Dec. 31, 2004 to Dec. 31, 2014 -- which includes the Great Recession -- you would have earned an annualized return of 7.6%. However, if you had missed just the 10 best days of that decade, you would have earned a paltry annualized return of 0.5%. If you had missed the best 20 and 30 days, you would have suffered losses of 3.7% and 7.2%, respectively.
Instead of timing the market, to use a Warren Buffet-ism, buy stocks as if the market were going to be closed for the next five or 10 years.
3. Seek out dividend-paying companies
Once you've accepted that you can't control the stock market and that your best bet for success is to hold over the long run, the next step is to seek out dividend-paying stocks. Single-digit dividend yields may not look that impressive on paper, but over a long period of time, they can really improve your growth prospects and speed up your retirement date.
Dividends also provide three basic benefits to investors. First, and most obviously, they add money to your wallet, which, depending on how the underlying stock performs, can be icing on the cake or a hedge against unrealized losses. Second, regular dividends substantiate the health of a company's business model. A company is unlikely to share a percentage of its profits with shareholders if its management doesn't feel confident in the long-term outlook and survival of that business. Finally, it shows that a company's management team takes its fiduciary responsibilities to its investors seriously.
4. Reinvest your dividends if possible
The next important step for retirement planning is to reinvest your dividend payments -- in more shares of the same stock if possible. Reinvesting your dividends creates a virtuous cycle: Purchasing more shares with your reinvested dividends leads to a bigger dividend payout, which allows you to buy more shares through dividend reinvestment, which leads to an even bigger payout, and so on.
For example, $100,000 invested in a stock that yields 3% and grows at an average of 7.6% annually would grow to $990,000 after 30 years (not counting any tax implications) if you simply pocketed the $90,000 in dividends. (Keep in mind that this assumes the dividend payment hasn't grown whatsoever, which is unlikely.)
On the other hand, reinvesting these dividends boosts your total shares held by more than 40%, increases your dividend payments by more than $23,000, and nets you almost $300,000 more at the 30-year mark. Plus, if the dividend grew by an average of 3% annually, this outperformance would top $415,000 by the 30-year mark! That's the power of dividend reinvestment.
5. Buy companies that will change the world for the better
The last stock market tip for retirement planning is to seek companies that have the capacity to change the world for the better. This could entail anything from introducing a new technology or drug to simply improving an existing product that we use every day.
A simple example here is Chipotle Mexican Grill (NYSE:CMG), the fast-casual restaurant chain that uses locally grown vegetables and has made a "Food with Integrity" pledge assuring consumers that they're getting high-quality meats with little to no antibiotics or hormones. It's far from the cure for cancer, but Chipotle's focus on healthier foods is helping to make a change for the better. Finding such companies that have the potential to create positive change could put you on the path to a successful retirement.
In sum, history shows that investing in the stock market is your best path to a comfortable retirement. The only question remaining is whether you'll answer the call and become a long-term investor or take your chances elsewhere.