Contrary to what you might (reasonably) conclude from most of the content on this site, we’re not anti-stock market. Rather our broader goal is to make the twin points:
- The world of investment options is far broader than is often portrayed in the popular press
- If you don’t want to invest in stocks, it’s still quite possible to construct a well-diversified portfolio without them
The US stock market has shown a strong historical tendency to rise over time. Since the stock market is, at least in a loose sense, a proxy for the US economy at large, that upward slant shouldn’t be a surprise. Likewise, it is undeniable that there have been plenty of periods throughout history when rises in the stock market lead to rapid wealth creation within personal accounts.
So we like the stock market just fine. It’s just that we think it’s important to understand it for what it is, and realize that it’s a better fit for some circumstances than others. If you start to think of the stock market as a tool which serves as a means to an end, then it becomes clear very quickly that you would expect it to work better for some situations than others.
One major problem with the stock market, as it relates to planning for individuals who are heading into retirement, is that its return move around a lot from one year to the next. It is not at all unusual for the stock market to soar one year, only to experience sharp reversals later on; reversals which lose so much value that years’ of future appreciation are required to get back to the previous high (for example, the period from x to y and again in x to y).
Investors who can wait out these dips are in a much less risky position than those who may have to have use some of their money before the downturn has a chance to resolve itself. That’s because when you take money out during a downturn, the losses become permanent. Even if the market goes back up, it won’t do you any good because when you liquidate the position, there’s nothing left to participate in the future rising tide.
The ability to wait is a key factor in whether or not stocks are a good fit for a particular investor. In general, our suggested rule of thumb is 5 to 10 years. If you can go that long without needing your money, then stocks could be an OK fit. So individual investors in their thirties or forties would typically meet that criteria, as would large, professional portfolios like pension funds and university endowments.
Someone who’s retired, or is about to retire though, wouldn’t fit the criteria. That’s because in retirement the money for your bills stops coming from the results of your efforts (e.g. pay check, business profits, etc) and has to be funded by your savings and what they earn.
The time factor may be the only thing that sets retires apart from the other investors. But that one difference is enough to make holding stocks a lot more risky than an investor who can wait out a long downturn. The waiting investor may not end up getting much positive benefit for waiting, but they do avoid the major negative of booking the permanent loss that a retires faces.