The stock market's erratic behavior over the past 11 years has frightened investors. Remember this time last year, when everyone was talking about the lost decade? The volatility in 2010 alone was pretty unnerving, especially May's flash crash.
Was it worth it for investors to stick it out? Certainly it was for young investors who contributed a portion of their salaries to a retirement vehicle throughout the tumultuous duration.
Let's go back to January 2000. A novice investor who contributed 6 percent of her salary along with a company match of 3 percent in a cheap Standard & Poor's 500 fund would have ended up with $52,000 by the end of 2010, according to an analysis published in the Wall Street Journal. That analysis, conducted by Financial Engines based in Palo Alto, Calif., assumes the employee earned $40,000 at the beginning of that time frame, received annual 3 percent raises and correspondingly bumped up her contribution each year.
But what would have happened to the fortunes of an older investor who already had some money in the stock market?
I asked Financial Engines to do an analysis using these assumptions: a 45-year-old investor in March 2000 has $50,000 invested in the S&P 500 and earns $50,000 per year. A gambler by nature, he contributes 10 percent of his salary and receives a 3 percent company match, directing it all into the S&P 500 fund. Like the younger investor, he gets 3 percent raises each year and increases his contributions accordingly. What happens to his money?
Check out the gain/loss chart on his invested cash. He gets whipsawed. The first few years are pretty miserable, with the portfolio balance less than the amount invested for the most part. For example, at the end of February 2003, his account balance is $47,423, a drop of 32 percent from the $70,191 that was actually invested.
Disheartening, right? But that was absolutely the wrong time to get out of the market. And a fantastic opportunity to dive in. Too bad we're not all clairvoyant! Retirement planning would be a lot easier.
From the end of February 2003 through October 2007, the market climbed up 84 percent, according to Financial Engines. But alas, it then began a precipitous drop, hitting bottom at the beginning of March 2009.
"A key takeaway is that markets are volatile, and that equity investors should be prepared to accept short-term losses in order to realize longer-term gains," says Kenton Hoyem, Ph.D., a research associate at Financial Engines. "This is the classic risk-return tradeoff: the higher risk, in the form of potential short-term losses, is the price an investor must pay in order to get higher long-term returns."
Mattress vs. market investor
A skittish person who simply put his contributions and original investment of $50,000 under the mattress would have accumulated $132,167 by the end of 2010. But the investor who put money relentlessly in the stock market, through sleet, snow, rain and hail, would have gained nearly 17 percent, accumulating $154,620.
Was it worth it? Well, yes and no. Older investors really should invest more conservatively, constructing a portfolio allocation according to their risk tolerance and time horizon. A portion in a bond fund over the 11 years would have bumped up returns quite nicely, since the Barclays Aggregate, the bond benchmark, enjoyed magnificent gains in that period.
"It is important that investors have the appropriate investments for their stage in life," says Hoyem. "Younger investors, who have more time to wait for the recovery, can afford to invest more aggressively. Older investors, who may need to tap their investments in the near future, should be more conservative in their investments, as patience may no longer be an option for them."
Even so, patience would have paid off better than fear if investors bailed out at the wrong time.
What do you think of investing in the stock market? Is it worth the risk?
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