Imagine I told you that you lost $5,000. You’d be upset, but probably not devastated. Now imagine that I told you that you lost $50,000. You’d feel unsurprisingly worse.
But what if this is what happened?
- You are 30 years old and your $50,000 401k account declined by 10%. There’s your $5,000 loss. You’d think to yourself, “I’ve got time, I’m young and still saving aggressively for retirement.”
- You are 55 years old and your $500,000 portfolio declined 10% and you lost $50,000. Not only do you feel worse because $50,000 is a lot more than $5,000, but add to that the fact that it took you 20-plus years of saving to accumulate that half a million dollars and you were thinking of retiring in the next 5-10 years. This situation is much more concerning emotionally.
Admittedly, the 55 year old probably has a more conservative portfolio than the 30 year old, so it would likely take a larger stock market decline to achieve the 10% loss.
The fact remains that as your portfolio grows it gets harder and harder to stomach losses. This has a serious impact on the portfolio of anyone who is close to retirement, because mistakes can magnify losses. Selling at the bottom and missing a recovery costs a lot more money to the 55 year old than the 30 year old in my example.
Simple compound interest math shows that the largest gains for savers come in the later years of working since the portfolio is larger. The hard part is sticking with your investment plan, through the ups and the downs, to get those returns. There is a saying that “investors get the returns they deserve.” Bumps in the market like the last few weeks are the reason long term owners of stocks receive higher returns than bonds and cash.
Dealing with the bumps while avoiding mistakes is the key to earning those returns.
Steven Elwell, CFP®
Partner, Vice President