5 Facts About Stocks Every Baby Boomer Should Know
If you were born between 1946 and 1964, then you're a baby boomer, probably in your 50s or 60s -- and you're either in retirement or approaching it. If you don't know much about stocks, then your financial health may not be as good as it could be. Here are five vital facts about stocks that every baby boomer -- and everyone else, for that matter -- should know.
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1. Stocks outperform alternatives
First off, let's give stocks the respect they deserve. Sure, there are lots of ways to make money, and some may work phenomenally well for some people at some times. But overall, over the long haul, it's hard to top stocks. Check out the following data from Wharton Business School professor Jeremy Siegel, who has calculated the average returns for stocks, bonds, bills, gold, and the dollar between 1802 and 2012:
Source:Stocks for the Long Run.
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If you're thinking that a 210-year span is a little much, note that the annualized growth rate for stocks from 1926 to 2012 was 9.6%, by the way -- also beating alternatives. In fact, Siegel's data shows stocks outperforming bonds in 96% of all 20-year holding periods between 1871 and 2012, and in 99% of all 30-year holding periods. So if you're saving for retirement, then stocks should be a major part of your portfolio, because they deliver the best long-term returns.
2. Stocks can make you wealthy
If you're thinking now that maybe stocks can make you rich, then you're right -- especially if you have time and diligence. The table below shows how much money you can accumulate if you invest varying sums each year and earn an average annual return of 8%:
Calculations by author.
Clearly, younger investors have even more growth potential for their money. (Consider sharing this article with any younger people you know!)
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3. You can save a bundle with tax-advantaged retirement accounts
A good way to help your stock portfolio grow faster is to make the most of tax-advantaged retirement accounts, such as IRAs or 401(k)s. There are two main kinds of IRAs: the traditional IRA and the Roth IRA.
With a traditional IRA, you can deduct your contributions from your taxable income, thereby lowering your tax bill. The money grows tax-free in your IRA, and it will be taxed at your ordinary income tax rate when you withdraw it in retirement. (There's a good chance you'll be in a lower tax bracket in retirement, too.)
With a Roth IRA, you contribute post-tax money that doesn't reduce your taxable income in the contribution year.The beauty of the Roth IRA, though, is that you can withdraw your savings in retirementtax-free.
IRA contribution limits for both the 2016 and 2017 tax years are the same: $5,500. There's also an extra $1,000 "catch-up" contribution permitted for those aged 50 or older (i.e., baby boomers), letting them contribute as much as $6,500 for the year. Both types of IRA allow you to invest in any stock, mutual fund, or bond of your choice.
With 401(k) plans, there are much higher contribution limits. For the 2016 and 2017 tax years, they're $18,000 for most people, plus $6,000 for those 50 and older. A 401(k) plan will typically offer a limited menu of investment options for your money, but there's likely a simple index fund or two among them that will aim to track the overall stock market's performance. A key benefit of 401(k) accounts is that they often come with matching funds contributed by your employer. That's free money, so be sure to contribute at least enough to max that out. Note, too, that more and more employers are offering Roth versions of 401(k) plans, which are worth considering if you want your tax break in retirement, rather than now.
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4. Dividends are more powerful than you think
Many investors don't realize how much dividends can enhance their returns. According to datafrom the S&P Dow Jones Indices, dividend income made up 33% of the monthly total return of the S&P 500 between 1926 and 2015.
If that's not convincing enough, consider this: Researchers Eugene Fama and Kenneth French, studying data from 1927 to 2014, foundthat dividend payers outperformed non-dividend payers, averaging total returns (i.e., capital growth plus dividends paid) of 10.4% versus 8.5%. The table below shows how that seemingly modest difference in growth rates can make a big difference over the long run to annual investments of $10,000:
Calculations by author.
Image source: Getty Images.
5. Inflation will shrink your purchasing power
Finally, remember to keep inflation in mind as you save money for your retirement and assess your performance. Over many decades, the average annual rate of inflation has been around 3%. If you're earning less than that from your investments -- say in bonds or money market accounts -- then you're losing ground, and the purchasing power of your investments over time is shrinking, not growing. If you're averaging 8% annual growth, then it may be more like 5% in "real" terms -- i.e., with inflation factored in. That's all the more reason to invest a big portion of your nest egg in stocks, even though they carry more risk than bonds and CDs.
Baby boomers should generally have 40% to 70% of their portfolio invested in equities. The right allocation for you depends on how much risk you can stomach and how much money you need to save in order to fund a long, comfortable retirement.
Knowing these stock market facts can help you plan, save, and invest more effectively for retirement. Don't leave your retirement to chance, hoping to get by on Social Security and a rainy-day fund. If you're a baby boomer who is not yet ready for retirement (which describes nearly all baby boomers), then now is the time to come up with a detailed retirement plan and save both diligently and aggressively.
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Longtime Fool specialistSelena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.