Historical Stock Returns and Investing for Retirement

December of 2018 was a stark reminder that the stock market can be very volatile. When investors begin to flee stocks in droves, losses in the stock market can pile up very quickly. Combine that with all of the programmed trading that exists today and we now have a market that is more susceptible than ever to large, quick swings.

The Long Run Still Looks Good For Stocks

In the short run, extreme volatility can keep investors up at night. Losing 15% in one month, like we saw in December of 2018, can create major anxiety and leads to a lot of people selling into the downturn.

Short run volatility in stocks can be tough to stomach when the money invested will be needed within the next few years. The downturn can mean one cannot purchase the new car, put money into home improvements, etc. Of course, this is one reason why money that will be needed soon should not be 100% invested in stocks. It’s just too risky.

So what about investing in stocks for the long term? Should a 35 year old investor who plans on retiring in 30 years really worry about a 15% decline in his retirement portfolio? In general, the answer to that is a resounding no.

In the chart above we see the rolling average 30 year annualized returns starting in 1926. As you can see, money invested in the S&P 500 never has a negative annualized return over any 30 year period during this time frame. This is just another way of saying that stocks always go up over a long enough time horizon. Put another way, the longer your time horizon, the more likely it is that your stocks will have a positive return. Not only will they have a positive return over a long enough time horizon, but they will almost always beat bonds.

Longer Time Horizons Allow For More Risk

We hear this all the time: Start investing for retirement when you’re young! This is very sound advice because the power of compounding means that the growth in one’s investments can skyrocket over long time periods. What should also be added to this sound advice is: Take more investment risk while you’re young! At least this should be true for retirement investments that won’t be needed for 25 or more years.

Using the power of compounding combined with achieving higher returns (due to higher risk) over a long time frame is a recipe for a secure retirement. If one saves $10,000 a year for 30 years and only earns 3% per year, they will have about $475,000 at the end of that time frame. But if one takes a bit more risk and earns 7% per year, the amount at the end of 30 years would be nearly $1 million! That is one good example of the power of compounding at work.