The Road to Recovery
After the big stock market decline this fall, there's a temption to try to make up lost ground quickly. That's likely to be a mistake. Instead, it makes sense to put a plan together and stick to it.
By trying to recover quickly, one is apt to take too much risk. While we can win those bets sometimes, the global meltdown this fall has been an instructive lesson in the dangers of inappropriate risk.
There's also the temptation to take no financial risk and that's just an illusion. Every course of action involves risk. Keeping savings in cash (besides the unusual risk we had this fall) involves the "opportunity cost" of losing out on potential investment gains as well as the loss of purchasing power from inflation. A dollar simply won't buy as much in a year as it does now.
Taking too much risk brings the possibility of loss of principal.That has been readily apparent this year. What has not been apparent has been the virtue of long-term investing in the stock market.
With the wild gyrations the market has been taking, it's too easy to look on it as a risky "casino." While that may be true in the short run, it's not the case for the long run. Money that is needed within five years shouldn't be in the stock market. For longer term money, the odds are that it will produce satisfactory returns if it is properly diversified.
Over the last 90 years -- which is as long as we have good data -- the stock market has returned 10 percent per year as measured by large cap U.S. socks. Properly diversified into other categories, particularly small cap value and international stocks, returns have averaged two to four percent higher. At 10 percent per year (and for the moment ignoring fees and taxes), money doubles every seven years. At 12 percent, investments double in six years. If an investor has an IRA, which builds up funds without taxes till withdrawal and minimizes fees, he can get close to these returns.
With these kind of returns, financial accumulation is powerful -- tripling in twenty years without undue risk. The key to getting these powerful returns is broad-based diversified in low fee funds with a tilt toward small cap value.