I have been speaking with my
daughter and other young adults about how to invest for retirement.
I strongly recommend
index funds. In particular, I recommend
choosing an index fund based on the
S&P 500 or some other measure
of the American stock market as a whole.
My father said that if you
invest in the stock market, you will get rich when everyone else gets
rich. In times of inflation, stock values will automatically ramp up
to keep pace. Fixed interest investments such as bonds, however,
will require your constant attention.
If corporations respond to
growth in the economy by rewarding shareholders rather than giving
raises to workers, workers can benefit by becoming shareholders. Be
warned, however, that workers who invest their retirement funds into
the stock of their own employers risk losing both their income and
their retirement simultaneously if the employers suddenly go out of business.
Workers are better off investing in the economy as a whole by
choosing a
diversified index fund.
My father also said that if
the stock market collapses, you will become poor when everyone else
becomes poor. I would not worry about this because you can ride out the
dips if you have no immediate need to withdraw your funds. A diversified
collection of stocks held for decades is no riskier than bonds held
for the same period.
Once when I spoke in praise
of investing in the stock market, my uncle protested that he had lost
almost half of his retirement funds due to a stock market dip. I responded
that this was because he had not been investing in the stock market
over his entire career. In fact, he had invested his retirement
funds very conservatively over his lifetime until he decided to move
everything over to the stock market just at its peak before a
collapse.
Dollar cost averaging is a
technique in which you invest a fixed amount in the stock market with
every paycheck. This buys you a lot of stock when stocks are
undervalued and less when stocks are overvalued. In the long run,
this works out in your favor.
When it comes time for
retirement, most recommend re-balancing your portfolio to invest some
of your income in safer investments. There are a few who say that
you should keep it in the market and let it ride. Keep in mind that
you will probably live for at least a
couple of decades past
retirement.
Some people recommend
investing in other inflation-proof assets such as real estate. Being
a landlord, however, requires more effort than you expect. Even if
you hire a company to manage your rental properties for you, you now
have to keep an eye on the management company to ensure they are
continuing to serve your interests.
Investing in individual
stocks can also be more effort than you expect. After studying the
complexities of corporate finance in graduate school, I realized I
was better off focusing my attention on my day job and other
pursuits. With dollar cost averaging into an index fund, you can set
up automatic contributions once and then concentrate on more
important matters in your life.
You might consider letting a
money manager pick individual stocks for you. On the whole, these actively managed funds perform about the same as index funds.
They cost you much more, however, as the managers take their fees.
So do not be a
contrarian.
Invest in an index fund. Set it and forget it.