Young people should be investing in stocks — here’s why

It’s alarming to me when I read that a significant percentage of young investors  distrust the stock market  so much they are not including equities in their retirement plans.

I’m not sure I really believe that, but more than half a century of working with investors has taught me that emotions can easily overwhelm logic and facts, leading to unfortunate results.

For anybody who doubts the long-term advantage of stocks over bonds, I’m going to lay out my best case today.

This is one of a dozen or so major forks-in-the-road that investors face. Each one can have huge implications for long-term retirement planning. I believe that each of these can be worth $1 million or more.

Stocks-instead-of-bonds is the granddaddy of all these forks.

Obviously, you don’t just make some decision and immediately find your wallet or purse full of big bills. You have to invest money, make a good plan, and stick with the plan for a really long time. Sorry for that!

For the numbers to make sense, we need a common set of assumptions.

So in this discussion, and the discussions in a series of articles to follow, we’ll make three core assumptions.

• First, a 25-year-old starts saving $500 a month and continues to do so for 40 years. The $500 may be a challenge at 25. But I’m not calling for any increases in this savings rate. So it is likely to get easier over time.
• Second, this investor retires at age 65 and lives for 30 years. During retirement, she withdraws 4% of her account balance at the start of every year.
• Third, her lifetime reward for all this is the total of the 30 annual withdrawals she takes plus the value of her portfolio when she reaches 95 and her heirs inherit that amount.

Since 1928, the S&P 500 has compounded at 11%, but for this discussion I’ll assume 10%. Intermediate-term U.S. government bonds have compounded at 5%.

Based on those historical returns plus my three assumptions, here’s a table showing the results of three choices our young investor can make to start this process: No stocks (all bonds, in other words) vs. 10% stocks vs. 100% stocks.

The bottom line (literally) shows three very different outcomes from the exact same $240,000 savings. The differences derive only from the mixture of stocks vs. bonds.

Hidden in the data underlying this is another interesting tidbit. These results are based on the premise of saving $500 every month. In order to calculate the numbers in the middle column, we assumed only $50 per month went into stocks (and earned 10%).

That’s a total of only $600 a year, or $24,000 over 40 years. At age 65, that part of this “middle” portfolio was worth $279,730. After total withdrawals of $824,733, this partial portfolio (invested 100% in stocks) was worth $1.4 million, for a total “lifetime payoff” of $2.3 million. (That $2.3 million is part the equity component of the $4.0 million shown in the table.)

Translation: If you want a lifetime payout (as I defined it above) of considerably more than $1 million, you can get it from savings of only $50 a month and a 10% long-term return — plus a lifetime of patience.

If you find my stocks vs. bonds comparison valuable, stay tuned for future articles. We’ll compare small-cap to large-cap, value to blend, and show what could happen – based on our assumptions of 40 years of saving $500 a month and retiring for 30 years — if you put together a U.S. four-fund portfolio that included large and small, value and blend.

For more, check out my podcast:  Stocks vs. bonds: All or Nothing. And here’s a  link to a free copy  of  We’re Talking Millions! 12 Simple Ways to Supercharge Your Retirement.

Richard Buck contributed to this article.

Paul Merriman and Richard Buck are the authors of  We’re Talking Millions! 12 Simple Ways To Supercharge Your Retirement .