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Don’t Trust the Stock Market? Think Again!

I realize many people are skeptical that stocks are a good way to save for retirement. It can seem like such a gamble or leap of faith. They just don’t trust that their hard earned dollars will be there when needed.

Education is a key component of developing that trust. Statistics indicate those with more financial education tend to see stocks as a good tool to save for retirement and are more likely to invest. One piece of compelling evidence for stocks is this; dating back to 1926 the S&P 500 has returned about 10% per year annually (through 2011). That’s pretty decent and worthy of consideration!

Mistrust and skepticism may in part be attributed to a couple of key issues. First is the variability of returns. As we know prices move all over the place and we may not experience that ten percent average in the years we’re in the market. Just a few years back journalists were pointing to a ten-year period for the S&P 500 where investors made no money at all. And there was a 40-year stretch where long-term government bonds outperformed stocks (a rather rare occurrence.) Yes, there are extended periods when stocks don’t deliver the long term average return. But, the fact is they do have the potential to grow over time at a rate that is greater than inflation. And that is a key reason to have an investment portfolio, to maintain your purchasing power as prices rise over time.

The second source of skepticism comes from our own behavior. We act in ways that hurt our returns such that we don’t earn anywhere near the averages, often by a large margin. There have been studies over the years (see Dalbar), which have documented the tendency for people to trade too often, moving in and out of the market and/or chasing performance. Chasing performance is the selling of an existing fund to invest in one that was recently cited as being a top performer in its category.

There is also the herd phenomenon. Stocks rise to levels where they make news every day and attract the “Johnny-come-latelys” into the market. Then within six months the market tanks. Johnny feels huge regret and sells at the bottom just a few months before the market rises again. It sounds obvious and well…silly, but it is quite common. We experience deep regret and swear not to repeat the mistake.

A basic level of skepticism around any investment is healthy, if it pushes you to investigate and ask questions. However, a rigid stance of mistrust and cynicism toward stock investing can be to your detriment. Herd behavior and our emotions lead us to poor choices. Returns can fluctuate wildly heightening our anxiety. Education often helps people gain trust as their understanding grows. Over the long term stocks can add a much needed growth engine to your retirement savings. Really!

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