How Long You’ll Be Investing
A couple of weeks ago, I spoke to a group of elementary school teachers about their 403(b) plan (the 401(k) equivalent for non-profit employers, in case you didn’t know). Like most investors, they were a bit shell-shocked over what’s happened over the past 20 months or so.
Many asked whether they should be contributing to their retirement accounts at all, given that the S&P 500 is still down approximately 40% from its October 2007 high, even after the rally we’ve seen since early March. It’s understandable. By some metrics, the past decade has been even worse than what happened during the Great Depression.
My answer was, yes, you should still contribute to your retirement accounts. The tax breaks are just too good to pass up. Money you contribute to a traditional 401(k) or 403(b) reduces your taxable income, so it’s essentially a tax deduction. Plus, you don’t pay taxes on any interest, dividends, or gains until you withdraw the money in retirement. That’s known as tax-deferred growth, and ends up providing more money in retirement.
Now, if your boss doesn’t match your contributions to the company plan, you might be better off in a Roth IRA, which doesn’t give you a tax break today, but gives you one in retirement. Whichever account you choose, you should still keep saving; it’s the only way you’ll be able to retire. If you can’t stand the volatility of the stock market, invest in bonds or even cash. Just keep saving!
Stocks for the Really Long Run
That said, I do think most investors should have some of their money in stocks. Especially the 30-something teacher who told me that she couldn’t stand seeing her account balance drop, drop, and drop last fall, so she sold everything and has been in cash ever since. Again, I understand — it’s not easy watching years of savings seemingly disappear in a matter of months. But it’s important to remember that investment success isn’t based on how much you have right now, but how much you’ll have when you need it. Staying too conservative for too long can increase the chances that you’ll come up short.
The truth is, folks, your investment time horizon might be longer than you think. Let’s assume the teacher I met is 35 years old and plans to retire at 65. That’s 30 years of investing ahead of her. But she won’t sell all her investments on the day she retires.
Sure, she should have at least 40% of her money in bonds at that point — and perhaps even more, if she’s more conservative — but she can’t play it too safe. Because at age 65, the average woman lives another 20 years; the average 65-year-old dude lasts another 17 years. Marriage actually increases the chances that one spouse will make it even five years longer (my wife doesn’t believe it). And those are the averages; half of the population will live longer.
Add in lengthening life expectancies, and our 35-year-old teacher could reasonably expect to be living — and investing — well into her 90s. Of course, by then she should be playing it very safe, perhaps with only 10% to 20% of her assets in stocks. But it means that a stock (or mutual fund) that she buys today could still be in her portfolio by the year 2070.
Historically, with a timeframe that long, stocks have been the investment of choice. The chart below indicates how often from 1871 to 2006 that stocks beat bonds over various holding periods, courtesy of the fourth edition of Jeremy Siegel’s classic Stocks for the Long Run.
If 2007 and 2008 were included in these numbers, all those percentages would be lower, including a 30-year period when bonds beat stocks (assuming that the bonds used were long-term Treasuries). So I’m definitely not saying that stocks are riskless investments as long as you hold on long enough.
But I still find the historical odds very compelling, especially for a multi-decade investment time horizon. And let’s face it: Most of us will need stock-like returns to be able to retire and ensure that our portfolio keeps up with inflation over such a long timeframe. But that’s a topic for a future article.
In the meantime, have some fun (or grim reality) with the longevity calculator at www.livingto100.com to get an idea of how long your portfolio will have to last.
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There are 18 comments to "How Long You’ll Be Investing".
Don’t forget that many plans now offer Roth 401(k) or Roth 403(b) deferrals — if your plan doesn’t, you should be asking your plan administrator why not. The great advantage is that you can defer up to the 402(g) limit in either or a combination of both.
The other main thing to look at would be fees. If you have a “good” plan — the expense ratios in institutional share classes should be lower than retail share classes.
Also, who is paying the plan fees? Plan participants or the plan sponsor?
If one believes in what Aubrey De Grey talks about at TED, we may be living ALOT longer than we think. We should always be investing, but I also think we’re seeing a shift into changing what retirement actually means.
Do you find that most of the people you speak to understand the concept of buying more in a down market to increase future earnings or is it pretty common for most to panic and sell when their portfolios are down?
I guess that would just be another symptom of emotional investing. How do you coach people on avoiding that?
I like 401K for the tax shelter not much else Most of my 401k in is cash.
Robert,
I teach, and the 403b plan that my district offers does not come with any type of match. In fact I don’t know of a district around that offers a match on the 403b contributions. If that is the case in your situation, did you recommend to these teachers they should convert their retirement account to an IRA and then later do a Roth conversion, or did you tell them to keep socking money away in the 403b?
I don’t really see the advantage of a 403b, since most people in the education field don’t need to worry about being in a higher tax bracket. From my experience the 403b options are a choice thrown into the offerings of a district along with cancer insurance and other supplemental insurance and it’s just another way for the salesman to make a commission. When in most cases, since a match isn’t offered, the teacher would be better off putting the money in a Roth IRA (your words ).
I agree with the main point of you article. I continue to invest in mutual funds and stocks hoping that the ship turns around at some point.
Thinking that simply the passage of decades of time will guarantee a considerably fatter pot of money at the end than at the beginning is pure wishful thinking, yet there’s a collective dream that such patience must inevitably be rewarded.
“We’ve left our money in the market for 40 years, surely we deserve a fat return” seems to be the group-think.
What is so one-sided about this “investment hopefulness” is the idea that you keep buying through the 40 years and then liquidate the entire portfolio the day before you retire.
Objectively, though, why should the index be higher than 40 years ago on that particular day? Sounds like the naive hope of someone buying a lottery card, except so much more depends on it.
If you want to make money from investing over 40 years you must expect to sell the ones that have gone up over a shorter time period so you can bank some of the “profit” you’ve made, at frequent times throughout the 40 years.
Why not bank it when the price is higher than when you bought it? A profit is not a profit until you’ve pressed the “Sell” button, as people who thought in the recent past that their house was worth more than it is now.
Its only worth the amount you can get on the day you decide to sell, and there’s no guarantee that price will be a good price on the particular day before you retire.
But the idea of selling anytime before retirement seems like disloyalty to so many people.
Further, investigating selling options against your stock holdings would give you income day-to-day throughout those 40 years that I would guess could have an epic effect on the overall return.
Having a stock portfolio without selling options against it is like buying a block of apartments and then not letting any of them out.
But so many people look at me askance, with gaping mouths, that the idea of building a good return through the 40 years can possibly involve any activity beyond “buy and hold” and they regard it almost like sacrilege for anyone to suggest that this is a lazy, inadequate and ineffectual way to save for retirement.
I’m sorry if this sounds a bit like a rant, but “buy and hold” is a bankrupt strategy and leads to so much haertache at the very time you can least afford it.
If you believe that its enough to “buy & hold” for 40 years and it doesn’t work out, what are you going to do then?
This very fear should make you consider more pro-active approaches.
Indeed, in a bid to prevent themselves being strung-up by their customers, more nervous investment advisors encourage their clients to move their stock portfolio to bonds five years out from retirement just in case the market tanks just before they retire, and their clients become enraged.
“That wasn’t the dream you sold me!” they cry.
But why shouldn’t the market tank just before you retire?
This is a tiny concession to the idea that “buy & hold” even over many decades, won’t necessarily ensure you’re adequately richer at the end of the period.
It makes me angry because I’ve heard the sobs of hard-working women and men who just had the misfortune to retire just after a market fall – what is frightening is that they hadn’t ever considered that that could possibly happen.
The market doesn’t make a pact with you to treat you well if you leave large tranches of money in stocks for lots and lots of years.
Please manage your stock portfolio with that idea firmly in your mind – don’t learn this important truth when its too late to do anything about it.
You can take steps throughout those years to bank the profits as and when they arise, and gain further side-income from options – don’t depend on the price on the day of retirement – to me, that’s leaving too much to chance too late, and crossed fingers won’t influence the Dow Jones too much.
Good luck.
KC
I actually wrote about this on my blog yesterday. According to Living to 100, I’m going to live t0 92. According to the CDC, if you live to 65, you’ll probably make it to 85. I don’t think most American’s are actually planning for this. Yesterday’s blog post also has a great calculator to see how much you need to put away to have the kind of lifestyle you’ll need. Check it out if you have a minute.
Howdy, folks. A few replies to your thoughtful comments/questions:
To Tyler@FrugallyGreen: My experience is that there’s a wide range of reactions to market declines. The people who truly see them as an opportunity to buy stocks cheaper are the minority. For those who want to panic and sell, the main counter-argument is history; before the 2000s, stocks eventually recovered after every crash. But I do think it’s important to point out that there are no guarantees, and to cite examples like the Japanese stock market, which is still down 75% from its 1990 peak. Some people just can’t live with the uncertainty and volatility of stocks, which is fine. Just keep saving in bonds and cash.
To Chett: These teachers aren’t offered a match, but one of their providers is Vanguard, so I think the 403(b) is a viable option. (They are not yet offered the Roth 403(b), but I suspect that’s just a matter of time.) I explained that since most of their salaries are probably modest, and thus their tax brackets low, they might start with a Roth IRA, and then choose the 403(b) once the IRA is maxed out. However, if they’re married, they’re combined incomes could put them in a higher tax bracket; in that case, a traditional 403(b) might be the better choice.
To CamKC:
Many good points. For what it’s worth, I generally recommend that people begin moving to bonds when they’re within a decade of retirement. In retirement, people should have five years’ worth of income out of stocks to help ride out a bear market.
Well I’m apparently going to live to 102! Most of my family members are/were long-lived so I have always planned to live into my 90s. I started saving for retirement in my late 20s and I am still worried it won’t be enough.
“Objectively, though, why should the index be higher than 40 years ago on that particular day?”
Because the average business is likely to be more productive 40 years from now. Of course, there is no guarantee of that. But if productivity remains the same or declines, there are not going to be many shelters from the storm of consequences that result from that.
Its doubtful that whatever happens to the stock price in the next six months, or even six years, will make much difference in how much money a 35 year old receives for it in 30 or 40 years. The difference in how many shares they were able to buy now will make a huge difference.
There is little doubt that current prices are an opportunity to more shares with the same investment. For people who are in the “buying” phase of their life, this is a time to invest as much as possible. The real risk in investing now is that you will lose better opportunities if the market falls further.
CamKC’s post is excellent. Investing is not as easy as buy and hold. The numbers given out are very deceiving and the history of the stock market does not guarantee anything. Might as well go to Las Vegas. I’m tired of hearing that stocks yield more for the long term. What about stocks that go bankrupt??? I still feel the stock market is where people give money to CEO’s to afford their criminal salaries and bonuses. Even I’m not secure anymore with just cash because I feel the value of my cash will decline like the American Empire is declining.
Just because you will not be retiring for 30 years does not mean that stock losses do not have a big effect on your life in all the years before retirement. If you have less in your portfolio, you might not be able to afford to start your own business or move into the house of your dreams or take a great vacation that you would not forget. Plus, it causes stress to see much of your life savings washed down the drain.
When we are trying to save, the experts tell us that each dollar counts because of compounding returns. When they are trying to persuade us to put our money into risky investment classes, suddenly large amounts of dollars don’t mean much so long as you don’t need the money for 30 years.
I don’t buy it. I view it as propaganda from The Stock-Selling Industry (that millions of people outside of The Stock-Selling Industry have bought into as a result of the massive marketing campaigns).
Rob
“Plus, it causes stress to see much of your life savings washed down the drain.”
I think that pretty much sums up most of the misconceptions about investments:
1) You haven’t made any money until you sell, you also haven’t lost any money until you sell. A lot of people are under water on their home mortgage because they decided to “take cash out” of their house without selling it.
2) Investments are not “savings”. You bought stock in a company or loaned it money by buying their bonds. Its the same as if you invested it in your own business. Your emergency fund is “savings”.
3) If you have short term goals for money, then save it, don’t invest it.
4) The stress is caused by misunderstanding the market. There is no reason for anyone who is 30 years away from retiring to be stressing about fluctuations in the stock market’s valuation of their investment. No matter how dramatic they may be. They are looking, at most, five years into the future. Worry about global warming or some other problem that might actually impact the price you get for your stock when you sell.
“the experts tell us that each dollar counts because of compounding returns.”
If any expert tells you that returns on stock “compound”, run in the other direction. When you buy stock, you own the shares. You sell those shares at whatever the market price is when you sell. What you paid for them and how long you held on to them has nothing to do with how much money you made. Your return is the difference between the price you paid for the stock and the price you sold it for.
Maybe the different ways people “invest” in bonds makes the distinction between investment, savings and speculation. If you buy a bond and hold it to maturity you are guaranteed a return. That is savings. If the bond pays a coupon in cash that is a return on investment. If you sell the bond to someone else before maturity based on its current market price you are speculating that the bond’s market value will decline in the future.
With stock there is no savings. There are dividends, which are return on investment. And there are speculative gains from market pricing. The longer your investment horizon, the more likely it is that the market price will mostly reflect underlying value, rather than speculation. Of course if you just want to gamble, the stock market’s odds still are probably better than a Vegas casino’s.
While I agree in theory with all that this post says, sometimes I wonder about this advice. My folks took the uber-long retirement view, saved every spare penny, and built up a nice nest egg. However, my dad ended up passing away and then my mom soon afterwards. Both were in the 50-60 year old range, and hence never made it to retirement. While I am thankful for their saving, as ultimately I became one of the beneficiaries (along with my siblings) of their efforts and also of the ethic that they passed on, I often wish they had spent more on themselves.
The truth is you never know what is going to happen. You could get hit by a car tomorrow. Retirement planning is one goal to aspire to — at least it gets people to plan for the future in some way. But, if all energies are focused on retirement to the exclusion of living a little today, it can create an overly draconian situation.
Thus, an approach like the Balanced Money Formula approach from the book that JD reviewed a while back might be a better option, since it incorporates some funds for “wants” along the way. Sorry, I forget the name of the book…
Just a quick comment. The line:
“And those are the averages; half of the population will live longer.”
Is misleading and probably incorrect. True if you are talking about medians but it is highly unlikely that the mean (which is usually what is meant by average) sits at the exact mid point of the distribution.
Such a blasé assumption, dismissing basic maths makes me sceptical about the rest of the advice. A bit more thought next time please.
kk, that is my husband’s very argument as to why he’s 50 and has no savings. He might get hit by a bus tomorrow.
That’s true but the bus might only leave him disabled. Would you rather need it and not have it or have it and not need it? Personally I would rather plan to live to 100; then if I die at 50, I can leave my money to some person or cause I value and they can have the benefit. I haven’t lost nearly as much by being prepared as I would lose by NOT being prepared.
(btw I do spend some money on fun. There is such a thing as moderation.)
E-
Thanks for your response. Please don’t get me wrong, I think it is important to plan for the future. I am actually in agreement with you.
My issue is more with financial planners who seem to think “retirement” is the only financial goal a person might have. This is unreasonable and dangerous. It is also conveniently best for the financial planner because it keeps all of your funds invested with the financial planner into perpetuity.
A better financial planner will ask the client about their financial goals, and then work with the client to achieve the client’s financial goals. So, the better FP would listen to your husband’s argument, understand that one of your husband’s goals/desires is to enjoy some of the fruits of his labors today, but also help your family to flesh out other possible goals that might be worth saving for — perhaps saving a little for the day he stops working or as you said in case he would become disabled, for a boat or second home down the way, or whatever other financial goals you might have.
I think one reason “retirement” might produce the types of arguments that your husband (and others) make is the unspecific nature of the term “retirement”. What does “retirement” really mean? It is completely non-specific. It also tends to have an element of fear in it, i.e., if you don’t save for “retirement”, you might end up [insert undesired outcome here].
The article above reads like “retirement” is the only financial goal. It is just not true and, I think, is a convenient way for financial planners to cut corners and avoid doing the hard part of their job, which is to work with clients to define their financial goals better and to ultimately meet those financial goals. Some FPs focus too much on the financial part and forget completely the planning part of their job title.
PS. Just for the record, I am not a financial planner.
Unusually great posts. Here are some facts:
Bonds out perform stocks more often than the opposite. In fact bonds outperform stocks for extremely long runs. The difference is that when stocks go on their runs they outperform bonds by a large amount.
The vast majority of actual $$$ invested by folks occurs in a small amount of time between age 40 and 60.
The sequence of returns matters hugely on the success of the buy and hold strategy and that is a matter of luck.
The single most important characteristic for successful investing is the value approach which looks at the price that securities are bought.
Most people haven’t acquired the emotional temperment required for investing in the stock market.
Most people will pay more in taxes as they take their money out of tax-deferred accounts than they had saved by putting money into these accounts by 2 or 3 times.
Keep up the great comments!
People IMHO might be better served if they paid attention to income derived from investments rather than put all their eggs in the capital gains basket! After all income is the goal!