A reader writes:
As a "younger investor" myself looking for ways to retire with millions (we can all dream), I’ve been trying to start early and doing my research to figure out ways to gain an advantage in the long run. Starting young is always helpful. But the idea of timing the market makes me nervous. At the same time, with the market in the dumps – isn’t this the best time, as a 20-something, to jump in and fill my retirement portfolio exclusively with stocks? Maybe if I close my eyes and look away for a year, when I look back there will be a nice ROI.
She wrote this in response to my blog entry in June about research saying that if you’re young and investing for retirement, it’s a good idea to take a lot of risk — perhaps even more risk than putting everything in stocks. But do read the comments on that blog entry: they’re all very smart, and there are indeed good reasons not to borrow the money you’re saving for retirement.
What that means is that the first thing you do, if you’re in your 20s, is pay off your credit cards and all your other debt, with the possible exception of any low-interest-rate student loans you might have. Only once you’ve done that should you even think about saving for retirement.
But the second thing you should do, frankly, is think seriously about spending your income rather than saving it. People in their 20s get more value out of every marginal dollar than they will in their 30s, 40s, or 50s. Steve Levitt puts it really well:
The right reason to save is so you can even out your consumption. When times are good, you should save, and when times are bad, borrow.
Most likely, I would never be as poor again as I was starting out. That meant I should have been borrowing, not saving.
There’s a reason why it’s commonplace for parents to give or loan money to their children, while flows in the other direction are rare indeed: older people, as a rule, have more money — which means that one dollar is worth less to them than it is to their kids. When you’re in your 20s, a couple of hundred dollars can significantly change your standard of living; when you’re in your 40s, it probably won’t. (And if you do find yourself, in your 40s, at a point in your life where a couple of hundred dollars will significantly change your standard of living, I can assure you that having saved more in your 20s wouldn’t have changed anything.)
If it hurts to save, then, don’t. You’re only young once: enjoy it. No matter what the financial-services industry would have you believe, now’s not the time to worry about your income when you’re 80.
Okay, now we’ve got that out of the way, let’s say you’re in your 20s and you do have some excess cash you want to use for retirement — maybe you’re in the fortunate position of having an employer who’ll match your retirement savings, or something like that, in which case it’s a much better idea to try and maximize those 401(k) contributions.
In that situation, then yes, putting your savings 100% into stocks makes sense. The worst that can happen is that your retirement savings go down — but since you weren’t going to touch this money until you were in your 60s anyway, that makes zero difference to your present standard of living. Meanwhile, if your investments go up, as stocks usually do, then you’re precisely where you want to be: leveraging the magic of compounding for decades.
The key insight here is that you’re making relatively small regular contributions to your retirement account. As you earn more money in the future, those contributions will increase in size. The contributions you make at the beginning of your career are small enough that only a long period of good returns will turn them into something you can live off in retirement. If those small initial contributions are wiped out, you haven’t lost that much, by the standards of your 70-year-old self: remember, older people are richer. On the other hand, if they do well, then you’ll feel great.
So yes, if you’re saving for retirement, put 100% of your contributions into stocks. (If you want to start getting sophisticated, then maybe buy ETFs of other asset classes like real estate and commodities, but let’s keep things simple for the time being.) You’re not timing the market, you’re just giving yourself the maximum amount of time to see that investment blossom over the decades into something really substantial.
But if you’re not saving for retirement, don’t let the financial services industry guilt-trip you into thinking that you’re doing something horribly wrong. Retiring with millions is all well and good, but don’t let it prevent you from going out and having fun today.