Worried About the Stock Market and Your Retirement Savings? Read This.
This article is for information only and doesn’t call for any action.
In the last few days, a number of readers have written to The Simple Dollar regarding the recent downturn in the stock market. Here are a few of those notes, starting with one from Dave:
45 years old, aiming to retire at 62. I have been in the aggressive portfolio in my 401(k) since signing on back in 1998 and contributed regularly. I didn’t pay attention to it during 2000-2002 or in 2008 but now I pay attention and these recent drops are killing me. How bad am I hurt if I move things to a less crazy investment?
and one from Charlie:
61, was thinking about retiring next year but stock market is ripping my retirement apart! Help!
and one from Ally:
I’m started to freak out about the stock market as I see my investments in my Vanguard index funds plummeting every day. I know I need to wait it out as I’m only 34 but it’s really starting to panic me. Intellectually, I know to stay put and watch the gains as the market “recovers” but I worry that I may actually need some of that money before it goes back up and start operating from a perspective of scarcity vs. abundance (even though I have lived by the rule of thumb that if I think I’ll need it in 10 years, put in high interest savings instead). All of a sudden I start imagining scenarios where I’ll need it sooner and put my finances in jeopardy.Please help talk me off the ledge!
We’re all seeing the same thing. Depending on what numbers you’re using, over the last two and a half months, the stock market has lost between 10% and 15% of its value. That means, of course, that if you have a large portion of your retirement savings invested in the stock market, you’ve seen a similar drop in the value of your retirement savings.
Part of what has made this dip so stark is that it comes at the end of a very long positive run for the stock market, dating back almost ten years. Ten years of almost constant growth in the value of the stock market is a historical run, one likely only possible because of the enormous dip of 2008 which gave the stock market a very low point to start from.
As you can see, those factors have caused a lot of people to panic and consider changing their retirement investments. My advice? Well… in honest truth, I have not looked at my old 403(b) or my Roth IRA in the last three months. At all. Even if I did look, I wouldn’t change a thing.
Here’s how my thinking works on all of this.
We Look at the Short Term When We Should Look at the Long Term – and That’s a Mistake
The stock market is an awful short term investment. It can lose a significant percentage of its value in just a few days, often seemingly without warning to the average investor. Even over the course of a year or two, you might have individual years where it goes up 20% and other years where it goes down 40%. It’s really hard to plan around that.
If you are going to need your money back in less than ten years, you probably shouldn’t be invested in the stock market.
The thing is, most of us are more than ten years from retirement. We’re invested in stocks as a long term investment. Even people in retirement should have some portion of their retirement savings in the stock market because there’s a good chance that they’re going to be around more than ten more years and they should be investing for that timeframe. At that point – a timeline of more than a decade – you have to start looking at long term returns and averages rather than individual years, because individual years aren’t really all that meaningful when you’re looking at time periods beyond ten years.
I like to think of the stock market as a simple gambling game. It’s a model that helps me make sense of it.
Imagine that there’s a game where there are nine red balls and one black ball that randomly come out of a tumbler, like drawing lottery numbers. If the black ball comes out, you lose 40% of your bet. If any of the nine red balls come out, you win 10% of your bet. However, you have to bet your whole retirement savings. What do you do?
Well, for me, it depends on how many times I can bet. If I can only bet once, then it’s probably not a worthwhile risk. I could lose 40% of my bet right away! Not good! However, if I can just stand there and keep betting more than ten times, I’m going to do it and just keep letting my bet ride over and over again. Nine times out of ten, I win 10% of my bet, which far more than makes up for the 40% I lose one time out of ten.
If I think about nothing but that first ball, I’m probably not going to bet and I’m going to want to take my money off of the table. It’s only when I think about the fact that I’m going to be around for thirty or so balls to come out of the tumbler that I begin to feel good about it. (In fact, I probably don’t even pay much attention at all to the individual balls coming out of the tumbler, because it really doesn’t matter to me.)
The thing is, it’s pretty scary when the black ball comes out of the tumbler. Suddenly, a large chunk of our money is gone, and it’s really tempting to take your bet and run away.
That’s silly, though. It’s like quitting a game of basketball because you missed your first shot. If you were only going to care about your first shot – or your most recent shot – you wouldn’t bother to play that game at all. If a basketball player quit when they miss a few shots in a row, no one would ever play basketball. At the same time, no one would bet their entire life savings on one single shot of the basketball.
For most people, the stock market is a very long term investment – more than ten years – and making decisions on that investment based on the last month or two is a grave mistake. It’s like firing Michael Jordan because he missed ten shots in the game last night and his team lost.
Instead, look at the last ten years of stock market returns when making your decision, because that’s the kind of time frame you care about. Don’t look at this chart when making financial decisions; look at this one instead. In other words, look at the long term, not the short term, because if you’re investing for more than ten years down the road, the short term is meaningless.
We Listen Too Much to Current News and Media – and That’s a Mistake
The United States currently has three different major 24 hour news channels available on most cable providers, two devoted financial television channels available on many cable providers, and countless journalists and prognosticators trying to make a name for themselves on the internet, particularly on social media.
All of that has to be filled with some kind of content, and it’s usually whatever content that they can find that will attract eyeballs.
What attracts eyeballs? Fear. It’s why disasters get breathless coverage. It’s why the efforts of Washington are constantly painted to be doom and gloom and disastrous and even evil. That kind of coverage is constant, too – it’s around the clock on news networks and social media.
The same exact thing is true with the stock market. A 10% drop in the stock market really isn’t anything unusual – it happens every few years at least – but to hear the news networks and social media and the prognosticators and the talking heads tell it, it’s apocalypse out there. The sky is literally falling, everyone is going broke, people are jumping out of buildings on Wall Street.
It’s being reported as something unique and something disastrous because that’s what attracts eyeballs, and eyeballs are what makes the news networks and the reporters on social media lots of money.
There’s so much time to kill and space to fill that the same things get reported on over and over and over again until the urgency of the supposed disaster seems almost overwhelming, driving people to emotional extremes.
My belief is that social media and cable news are not very useful for understanding the world. They present current events from the singular angle that makes them the most money and that’s through pushing emotional buttons, mostly fear. That emotional button drives people to poor decisions, and it’s abundantly clear when it comes to finances, where
December 18, 2018 at 07:45PM