Monday, November 17, 2014

Breaking News ... Japanese Stocks Fall Hard ... Young People and Their Future Financial Security ... Investing in Stocks for the Long Haul is the Best Plan

Surprising economic news from Japan caused its stock market to fall 3% overnight, thus setting up perhaps an interesting day for trading in the U.S. market. (See Japan Stocks Slide After Gloomy GDP Data.)

While the Japanese economy continues to struggle against deflation and is in recession, that will create what traders call a 'headwind' for other markets. Long term individual investors in the U.S. should take advantage of any severe reaction to the downside (if one happens) by U. S. stocks and treat it as a buying opportunity. In other words, while markets are volatile and often trade lower during 'headline' world news events, that's not a reason for long term investors to panic and sell. It's another reason to buy, because their favorite securities are temporarily 'on sale.'

All baseball players, from Little League forward, know that it's impossible to steal second base without first taking your foot off first base. That's just my rather simplistic way of saying that "Risk is." If we stay 'safely' on first, we're never going to score. On the other hand, if we try to steal second, we may get thrown out and record another 'out' for the good guys. But that out is a temporary setback, because we're still very much in the game.

And just like running the bases, there are no guarantees in life. Risk is simply a fundamental and necessary part of life's game.

Of course, the reward associated with successfully stealing second base is that the base runner is then in position to score on a single. A proper assessment of the risk/reward ratio before attempting to steal is all that's required.

And it's the same thing with saving and investing for the long term. While there's no such thing as a free lunch or big risk free rewards when investing, it's pretty close to a no-brainer if we are willing to consider the long term and be willing in the precious present to treat our future self with respect.

Here's how millennials need to think about retirement offers this solid advice to our young friends:

"Most young people are conservative with their money because they grew up in the midst of two financial and market crises — in 2000 and 2008 — that remain imprinted on their brains. Surveys suggest that millennials who have investment accounts prefer the apparent safety of cash to the apparent risk of stocks.

But cash isn’t going to get anyone to a secure retirement. So with decades to go before they stop working, what should millennials do now?

The best plan is to buck conventional thinking by flipping the traditional retirement pyramid on its head, reversing a decades-long fall in the personal savings rate, and using those savings to invest in stocks instead of keeping it in cash. . . .

Many millennials still think . . . that Social Security and home equity will be primary sources of wealth and income during retirement. But there are two problems with the base of this pyramid.

First, the fate of Social Security is out of our control. The cost of the entire program is about to skyrocket because of a rapidly aging population . . . . Today there are about four workers (i.e. taxpayers) for every retiree. When millennials reach their prime earning years, there will only be about two workers per retiree. It’s impossible to predict whether Social Security will support millennials to the same degree as it does current retirees. . . .

Second, real estate in fact has been a poor investment over the long term. Real home prices (that is, adjusted for inflation) were lower in 1997 than they were in 1894, according to the Case-Shiller Home price index. Zero return for 103 years is pretty lousy (and houses don’t pay dividends).

Save more, invest more

The best solution for millennials is to invert this pyramid by emphasizing personal accounts and in so doing reducing our reliance on Social Security and on our homes. Doing so would require that we reverse a decades-long trend in the personal savings rate. Double-digit savings used to be the norm; now we are saving less than 5.5% of our income. . . .

Millennials should focus first on their employee-sponsored retirement programs. It may require lots of personal austerity, but making the maximum contributions to your 401(k) early on (especially if your employer matches contributions) is one of the best things you can do for your long-term financial health. Once those are channels maximized, start building your "other assets," which can include investment brokerage accounts.

Focus on stocks

So if we save more, what should we do with that cash? The best long-term solution has always been the global stock market, but millennials are reluctant. . . . In a recent generational survey conducted by the Investment Company Institute, millennials were less willing to take risk than Gen-Xers or Baby Boomers. Just 21% of those under age 35 said they had “above-average” or “substantial” willingness to take risk.

But millennials must change their definition of risk. We all tend to define risk as the choppiness of an investment or the potential that it will hurt us badly in the near term. But the whole point of investing in the stock market is for the long term. If you need to spend whatever money you are investing in the next five years, maybe even the next 10 years, then you should have less of it in stocks. But if your goal is to invest for later in life — for retirement, or your kids' education — then the least risky asset has always been the stock market.

Consider this. If you are 25 years old, you have roughly 40 years until retirement. Compare that time horizon against more than eight decades of data for U.S. stock returns. Over those eight decades, the worst-case scenario for every dollar invested in stocks over a 40-year period was $1 growing to $4.50 — after accounting for inflation.

Keep in mind, this worst case scenario includes the Great Depression, World War II, and many severe market downturns. In sharp contrast, the worst-case real return for cash — the asset we think of as secure — was $1 being worth just 30 cents (because inflation slowly erodes the value of cash)....

There are many things we cannot control. What we can control is our savings and investing. We should of course do our best to grow our personal value and income, but at the same time we can carve out 10%-20% of our income and plow it directly into retirement and brokerage accounts. This is hard to do, but it’s worth it."

Summing Up

Too often we confuse share price volatility with a too risky investment environment for patient individual investors interested in their long term financial health. Rapidly changing stock prices, both up and  down, in the short run are not representative of the stock market's long term performance, and the long term is what matters most.

The plain truth is that owning stocks is the only clear winning way for an individual' investments to outperform inflation and achieve substantial real inflation adjusted returns over time.

And that long term we call tomorrow is just around the corner, no matter how far off we may wish it to be.

That's my take.

Thanks. Bob.

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