Millions of Americans are making this mistake. And yet it is one of the big reasons why many people will never accumulate substantial assets, never achieve financial independence and possibly ride the wretched E-train 10 times a week for more years than necessary.
What Is It?
They never commit to a consistent investing program that includes the asset class that tends to achieve the best long-term numbers. They never buy stocks.
Why are stocks important?
To obtain a decent standard of living, the prudent investor must make one’s money grow faster than costs. The latter include inflation plus taxes one pays on one’s investments (capital gains taxes, etc.).
Stocks—if one goes by their long-term performance going back to the 1920s—tend to return about nine to 10 percent a year. (By the way, I am citing large cap stocks. Small cap stocks, riskier than large caps, have an average rate of return of about 12 percent in that same period).
Remember that doesn’t mean you get ten percent every year. It means the average is about 10 percent a year over the long term. This is a justification for making a long-term commitment.
Stocks for the Long Run
That means buying stocks month in and month out through good and bad markets. And the recommendation for most people is to use the lowest-cost index funds. This is a strategy that I have used since I started investing in the early 1990s.
Slowly, without trying to pick market lows or highs, I invested in stocks along with some bonds and cash over 25 years.
Today I am slowly taking money out of my accounts. Again, I try to enjoy the benefits of stocks without trying to figure out if we’re in the middle of a boom or a crash.
I’ll let time work for me since I am likely to live another 20 years or more.
“Give Me Bonds”
By contrast, bonds in the same holding period going back to the 1920s have generally returned about three percent to five percent, depending on the kind of bond. And since inflation has averaged about three percent a year, you can see that stocks over the long run tend to yield a rate of return that beats living costs while bonds barely keep up with them.
In the former, the buying power of your money grows. In the latter, it barely holds its own and sometimes you lose buying power.
What are the net numbers on stocks? Ten percent minus three percent for inflation plus say another one percent or more for investment taxes leave the average investor of the last generation ahead about six percent a year (10 percent, minus three percent, minus one percent, nets six).
The 100 percent bond investor just about broke even. He or she didn’t gain much. And the name of the game in long term investing is to earn the most one can without taking excessive risks.
But there is another risk that many people take every day: They have never grasped the importance of stocks. So their money will likely never grow fast enough to ensure that they can achieve financial independence.
This danger recently came to my attention. I saw a poll that found that many young Americans shun stocks. Possibly it is they don’t understand importance of stocks in a portfolio or maybe they were spooked by the crash of 2008.
The Danger to the Young
Two out of three millennials aren’t interested in stocks, the asset class that tends to generate the best long-term results.
Those are some of the findings of a recent Bankrate.com survey.
“Americans, particularly younger adults, are missing out on an opportunity to build wealth and save substantial money for retirement,” the survey said.
Bankrate.com found just 33 percent of millennials and only 40 percent of the general population buy stocks. Fifty-four percent of the respondents say they’re not investing at all.
“The main reasons why people seem not to be investing are money and education,” says Jill Cornfield, a Bankrate retirement analyst.
Many young people “don’t seem to understand the importance of stocks,” she says. They should educate themselves in how to make money work for them.
Who are these people who shun stocks and who are those embracing them?
Education and income are two key indicators. The well-educated and those making good money usually aren’t afraid of stocks. They use them effectively.
Most survey respondents, 73 percent, with an income of $75K or more invest in stocks. But only nine percent of those earning $30K a year buy stocks.
Those who have a college education are more likely to invest than people with a high school education or less, 61% vs. 29%, the survey said.
Avoiding What Can Help You
Still, millennials and others who avoid stocks are hurting themselves, advisors warn (See Note: The Four Percent Solution). That’s because over decades stocks tend to outperform other kinds of investments.
For example, in the 85-year period between 1926 and 2010 large cap stocks earned on average 9.9% a year. Government bonds in the same period, returned 5.5 percent a year, according to figures by brokerage Raymond James. So large cap stocks beat government bonds by some 45 percent.
So why invest at all in bonds?
Over short periods bonds can outperform stocks. Then having some bonds in a portfolio with mostly stocks diversifies a portfolio, helping it through bad markets.
Either way not buying stocks and only obtaining low returns over decades make a big difference in reaching goals.
Many young people are missing the chance to accumulate significant assets.
Note: The Four Percent Solution
Four percent more on an investment doesn’t seem like much over a short period. And, in the beginning, it isn’t. But over a long period, as money compounds, it is huge.
Say you put $200 a month into a bond fund and earn four percent a year. But your friend invests the same amount and picks a stock fund that earns eight percent a year. That’s four percent a year better. Obviously, your friend does better than you, but by how much?
Over ten years, it isn’t much, only about seven thousand dollars more for your friend (36,833 versus your $29,548). But over 30 years the gap widens—your $139,273 versus his $300,059. And ten years beyond that, your decision to avoid stocks for the long run could be disastrous.
At the end of 40 years, his $200 a month in stocks turns into $702,856 while your bond investment returning four percent a year is only $237,180. That’s some $465,000 less than your friend.