Investing Basics | June 2016
Well, okay then. I hear you. You want an answer re: “How should I invest my retirement account?”
First, however I must offer the required disclaimer lest I run afoul of securities laws and regulations. I cannot and do not offer investment advice for anyone without discussing both their particular financial situation and goals, and determining the suitability of any investment recommendation.
That said, when we fund our IRAs, we generally have four main categories to consider: stocks, bonds, cash and what are now being grouped into “alternative investments”. Alternative investments include things like Real Estate Investment Trusts (REITS), commodities, managed futures and the ilk. We will leave that topic for another day.
The bulk of what your IRA should probably consist of stocks and bonds. Note the word “probably”. While I don’t wish to be mealy mouthed, I can’t emphasize strongly enough that portfolios should be based upon an individual’s (or couple’s) goals and concerns, not upon a general formula. That’s why I keep harping upon creating a financial plan and then sticking to it over the long haul.
But let’s get back to stocks and bonds. A quick look at historical data from various sources indicates that the average annual return for stocks, bonds and inflation for the period 1926 through 2015 is approximately:
Large company US Stocks: 10.0%
Long-Term Government Bonds: 5.5%
If you study the data over a long period of time you will see that after taking inflation into consideration, stocks have returned about twice what bonds have in the last century.
So why, pray tell, would anyone ever invest in bonds as opposed to stocks? You know that answer, of course. It’s those periods when the stock market goes down.
You have heard, perhaps said, “There ain’t no such thing as a free lunch.” The price you pay for excess returns of stocks over bonds is those downturns. An inexact approximation is that on average, every three years you give back one third of your gains. Furthermore, you also know that it goes way beyond gains: Some years you give back gains, plus principal, plus, perhaps, hope and joy.
I can give you information on bear markets, down turns, crashes and corrections, but it’s up to you to decide how you feel about stock market volatility.
And by volatility, I particularly mean down markets. I don’t think I’ve ever received a call from anyone complaining about how fast their account balance went up.
In February of this year, the S&P 500 had dropped by just over 10% from January 1. If you panicked, or lost sleep over that, you probably shouldn’t be invested in the stock market. That was a normal market fluctuation. However, if you’re not invested in the stock market, you are probably shut off from investment growth you need to fend off the effects of inflation over time.
‘Tis a dilemma. The only solution I can offer you is to have a portfolio of stocks, bonds and cash (the stocks and bonds via mutual funds, most likely) that best meets your needs financially and emotionally.
The only way to get there is through investing and planning. And to not forget to enjoy the journey.