- 4-Minute Article
- May 31, 2019
Retirement Planning Fundamentals: The Long-Term Benefits of Equities
Understanding the important role of stock investments can help you create a successful retirement accumulation strategy.
A common retirement savings strategy is built around regular contributions to your retirement accounts and a mix of investments diversified across multiple asset classes and financial product types. Each component of the strategy plays a valuable role, but stock investments — also called equities — can be an important piece of many retirement plans because they can provide the greatest growth potential for your portfolio.
Some investors choose stock investments as growth components of their retirement portfolio. As with all financial instruments, it helps to understand how equities work and recognize their potential and risks, including a possible loss in value. That understanding can help you choose the right mix of equities and other investments based on your goals and objectives, risk tolerance, and length of time until retirement.
The Basics of Equities
An equity investment is an ownership stake in a company’s assets and earnings. Equity returns are driven by potential increases in the company’s stock price and, in some cases, by direct payouts (called dividends) of a portion of company earnings.
For example, if you own stock in a company that launches several successful products and steadily increases its revenues, new investors might be willing to pay more for that stock than you did, increasing the value of your investment. However, growth is not guaranteed, and stock investments can lose value. This fact makes stocks riskier than other investments such as bonds, which represent a loan to a bond issuer in exchange for regular interest payments and the return of your money after a specific period.
There are many options when investing in equities, thanks to the 4,700 equity mutual funds and the nearly 1,400 equity-traded funds (ETFs) available today.1 These funds are readily accessible through most retirement accounts, such as 401(k)s. What’s more, each fund invests in a number of different stocks. Based on the investment objective of the fund, this can include investing in a variety of categories including those that hold stocks of larger or smaller companies, from specific industries, or from countries outside of the U.S. This offers options for diversifying your equity investments.
The Role of Equities in Retirement Planning
Although past performance doesn’t guarantee future results, historically, equities have been regarded as one of the best investment choices for pursuing long-term growth. Since 1928, the S&P 500’s average annualized return of 9.5% is nearly double the 4.8% average annualized return of 10-year Treasury bonds and far outperforms the 3.4% return for three-month Treasury bills.2
The tradeoff for higher potential returns is higher risk, notably in the form of short-term price declines. For instance, a company could unexpectedly lose money, reducing the price of its stock. Or the overall economy could slow, making investors less enthusiastic about stocks in general and pushing down the share prices of even successful companies.
Historically, however, stock markets have recovered after declines. During the 2008 financial crisis, for example, the S&P 500 lost more than 50% of its value between October 2007 and March 2009. But the index recovered four years later and went on to achieve five more years of gains.
The key to successful equity investing is holding on through downturns and having enough time for a portfolio’s value to recover. That’s easier for people with decades until retirement, but those nearing retirement should consider protecting themselves from downturns by shifting assets to investments and financial products that provide income to meet immediate needs while leaving some money in equities to grow for the future. Having this balance between stable income and growth potential can help you stick with your plan over the long term, which will help you maximize the full benefits of investing.
Work With an Advisor to Create Your Investment Strategy
For help answering questions about equities and developing a strategy that fits your goals, consult a financial advisor. Advisors can help choose the right amount of equities for your needs while recommending ways to balance equities with other investments and financial products that have little or no market risk, like some annuities. That way, you can take advantage of the benefits of equities at the level of risk with which you’re comfortable.