A major concern of most people is where to invest the retirement savings. Nobody wants to put their savings at risk and there are concerns about fluctuations in the stock market. Many people are uncomfortable investing in the stock market because of the higher risk associated with stocks. However, you should consider the following two points. First, inflation is a risk. Investing in “riskless” investments such as CD’s and short-term treasury securities may not achieve a rate of return higher than inflation (especially after tax). Therefore, even though your principal remains intact in riskless investments, the purchasing power is reduced due to inflation.
The second point is that the risk of investing in stocks is reduced as your time horizon increases. Historically, stocks tend to outperform other forms of investments and achieve a rate of return higher than inflation (including tax consequences). This makes stocks or equity mutual funds attractive for retirement planning because of the long-term investment horizon. Stocks may not be appropriate for investors with a short-term horizon.
We have included the following analysis demonstrating the impact of investing $5,000 annually in government T-Bills earning 3.7% annually compared to investing the same $5,000 in a small capital stock fund earning 12.1% annually. The rates of return are based on historical average rates of return between 1926 and 1992. The impact that compounding has on your investments is the ending balance of the investment in the capital stock fund is over 4.5 times the balance in the T-Bill account.
$5,000 Invested at the end each year for 30 years and different rates of return
|Year||3.7% Return||12.1% Return|