The S&P500 is up more than 11 percent this year and above 1,400 for the first time since mid-2008. This is good news, but many people are still on the sidelines worried about the global economy and the precarious conditions in Europe. The knee-jerk reaction may be to move all assets into a bank account or stuff assets into a mattress to avoid more volatility in the stock market. Even though some people may have a short-term peace of mind, this course of action is detrimental in the long run.
Below are reasons why, despite the volatility of the market, it is important to have some assets in the stock market.
1) To offset inflation.
Inflation is one of the greatest risks facing a person over his or her lifetime. Historically inflation has been 3-4 percent a year. Why is this so important? If you took $1,000 and stuffed it under your mattress today and inflation hit 4 percent, in 10 years your $1,000 will only be worth $665. If inflation reaches 7 percent, it will only be worth $338! Because people are living longer, losing purchasing power to inflation is a significant risk. Outliving your money is a serious consequence of inflation. It can be very difficult to maintain that purchasing power if you are on the sidelines, which is why it is extremely important to have a long-term view on your investments. Despite the ups and downs of the stock market, the average return from 1980 to 2012 has been 8.85 percent, so $1,000 invested in the market then would yield close to $15,000 today!
2) To use the magic of “compound interest.”
This has sometimes been called the eighth wonder of the world. Albert Einstein called it “the greatest mathematical discovery of all time.” What is it? When you invest money, you earn interest. The next year you earn interest on your original investment and also the interest you earned the previous year. You are making money off of the money you already made! Compound interest is primarily dependent on time and the interest rate. The longer your money has to grow, the faster it will grow. The greater the interest rate, the greater the reward. Just like a snowball, over time your investment grows larger at a faster rate.
How does it work? Say your goal is to build a $1 million retirement nest egg by age 55. If you start at age 24 and invest $5,000 a year at 10 percent, you’ll reach your goal. But if you wait until you are 34 to start, you’ll accumulate only $357,000 by age 55. If you start at age 44, you’ll have just $107,000. You can see the power of compound interest and why it is important to start early!
Even if you haven’t started investing, it is never too late to start. The best time to start may have been in the past, but the second-best time to invest is now! Historically, investing in the stock market has reaped one of the highest rewards. Continually reinvesting through the ups and downs will only increase your reward. Regardless of your personal situation, experts recommend having at least a portion of your money in the stock market. This is to make sure you can protect your purchasing power while taking advantage of compound interest and have your money work for you!