Investors in their 20's and 30's are perhaps facing one of life's great opportunities: a chance turn their modest savings into a significant chunk of change down the road. Most financial planners say the biggest winners coming out of this market will be those who load up on stock and mutual fund shares while they're selling at deep discounts. And young investors, who have decades to watch their money grow, are in the best position for a big-time payout in the long term. "This point in time may not be great for your parents, but this is absolutely what you want to happen when you're investing and trying to accumulate," says Gail Buckner, financial planning spokesperson for Franklin Templeton Investments."You couldn't have asked for a better opportunity to save for retirement."
With so many competing financial obligations these days, it's tempting to scale back on your retirement contributions rather than increase them. But here's an idea of the consequences in terms of dollars: If a young employee who earns $50,000 and contributes 6 percent to his or her 401(k), halting contributions—just for one year—will mean $48,000 less for retirement than if the contributions continued, according to Hewitt Associates. Stop contributing for five years, and the loss increases to a whopping $150,000. "You have to fight yourself right now," says John Carl, president of the Retirement Learning Center. "You've got rising expenses, wages being reduced, employers cutting [401(k)] matches. But this is the time to double-down your contributions if you can possibly afford it. If you can squeak even another $1,000 by, it can make a huge difference in the long term."
Risk in the market. While a 20 percent or 30 percent drop in the value of a 60-year-old's portfolio may mean delaying retirement, the impact on a 25-year-old's portfolio isn't earth-shattering (as long as that investor doesn't withdraw their money anytime soon). "The past five months have been tough for everybody, but this [younger] group has been the least harmed," says Michael Doshier, vice president of marketing for Fidelity's workplace investing group. "Let's say you started a job last year, making $30,000, and were putting in 3, 4, or 5 percent. You saved up $2,000 to $3,000 at best. So if your portfolio took a 20 percent hit, the loss is probably going to be offset by the amount you're contributing."
In the long term, stocks aren't as risky as you might think. According to Morningstar, large-company stocks gained an average of 10 percent per year between 1926 and 2008. During that time period, bonds returned an annualized 6 percent, and cash, 4 percent. Factoring in 3 percent for inflation, returns drop to 7 percent for stocks, 3 percent for bonds, and just 1 percent for cash over that time period. "If you're in your 20s, 30s, or even early 40s, you can ride this period out," says Elizabeth Ruch, financial adviser with Waddell & Reed in San Diego. "If you go back in history, these are the kind of markets where people reap the benefits of buying low."
Allocation. Although fund companies are reluctant to give specific recommendations for portfolio allocation—for any age group—a look at their target-date funds provides some insight. Fidelity's Freedom 2050 fund, designed for investors with a time horizon of roughly 40 years, contains 70 percent stocks; T. Rowe Price's Retirement 2050 fund is 73 percent stocks; and the most aggressive of the bunch, Vanguard's Target Retirement 2050, has nearly 90 percent of its assets in stocks. Whether you invest in a target-date fund or you're a do-it-yourself investor, "focus on accumulating more shares rather than focusing on dollars right now," says Carl. To put it simply, he adds, "one dollar today buys more shares than it did a year ago."
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Can you be too aggressive? For a while, many financial advisers have been telling young investors to put most of their money in stocks (or stock funds). The idea: With many years of tax-free growth ahead, compound interest can work its magic and market dips won't matter over such a long period of time. Some advisers have even gone as far as to recommend 100 percent stock portfolios in order for young investors to get the biggest bang for their buck.
But in volatile markets like this, the biggest argument against an all-stock seems to be investor behavior. "The average person doesn't have the stomach for it," Buckner says. "From a purely theoretical standpoint, if you look at the numbers over time, yes, you ought to be in stocks because they outperform over time, but they don't do it year in and year out, and even young people find that unsettling."
The market's plunge over the past five months has rattled even the strongest investors, she says, and it's had a dramatic impact on the way investors think about stock-heavy portfolios. According to Fidelity Investments, allocations to stocks among investors in their 20's and 30's is dropping. The average exposure to equities for someone in their 30's was 81 percent at the end of 2007 versus 73 percent at the end of 2008 (part of that is a move toward more diversification, and the other is pure math: equities are dropping in relative value compared with other asset classes.) If you're still sticking with a pure-stock portfolio in this market, Carl offers the following advice: "It can work if you stay the course. But you have to stick with it; you can't go halfway."