Don't let fear of loss scare you off
Are you afraid to save money because you fear you'll lose your hard-earned cash if you choose the wrong investments?
If so, you have a lot of company. A full 38 percent of Americans share your fear, according to a recent study done by Aite Group on behalf of Chase.
People are afraid they will stick their money in the wrong place. And it's understandable that they would be traumatized. Just five years ago, Americans went through one of the scariest periods in stock market history as the country endured a financial crisis and severe recession. During that period, people lost more than 50 percent of the money they had in the stock market. A $10,000 investment before the crisis would have turned into less than $5,000 at the worst point in the crash.
Research done in the field of behavioral finance shows that our brains don't tolerate losses well. We humans are so afraid that we'll lose money that many of us will bypass opportunities to make the money we'll need for our futures.
Let's say you're 35, have been through the financial crisis, but managed to hold onto $10,000 and are set on never losing a penny. If you park that money for the next 30 years in a savings account, you may have about $13,500 for retirement if it grows at 1 percent a year. Even if you add $5,000 a year to that, you'll end up with only about $189,150 for retirement. If you're lucky, that might give you about $10,000 a year to live on.
Of course, there's Social Security, too — about $15,500 a year on average for current retirees. But could you live on about $25,500 a year? You might think that looks pretty horrible. Yet behavioral finance suggests you still might be telling yourself that at least you won't lose anything if you park your money in that savings account. After all, you say, “$10,000 a year is better than nothing.”
You are right about that: $10,000 a year is, indeed, better than nothing.
But there has never been a time when every company had stock that lost all its value. So the stock market isn't likely to go to zero. Even in the financial crisis, stocks for companies such as Proctor & Gamble, Apple and General Electric didn't go to zero. In fact, what happened is that $10,000, which turned into less than $5,000 at the worst point of the downturn, is now worth more than $12,000. The market has been climbing since 2009, and it always climbs after a period of destruction.
Although you can never count on the future to be exactly like the past, that recovery should at least provide some confidence. Historically, the stock market has averaged a gain of 9.8 percent a year — sometimes losing big; sometimes gaining big. With a gain like that, a 35-year-old with $10,000, who invests another $5,000 a year, could end up with about $1 million at retirement age. That would provide about $40,000 a year to live on. If the next 30 years are treacherous, and the investments gain just 5 percent a year on average, the final sum would be about $392,000. That's about $16,000 for retirement living expenses a year.
Gail MarksJarvis is a personal finance columnist for the Chicago Tribune. Readers may send her email at firstname.lastname@example.org.