NEW YORK (CNN/Money) -
My wife and I are in our 30s and have about $25,000 to invest for retirement. I used to be the type of person willing to take a risk, but I'm scared to buy stocks now because of all of the problems with the market. What do you recommend I do?
-- Anthony, Chelsea, Mich.
There's a great scene in Woody Allen's "Annie Hall" where the young Alvy Singer -- an angst-ridden neurotic based loosely on Allen himself -- has been taken to the doctor by his mother because he's depressed.
When the doctor asks the boy what's bothering him, Alvy replies, "Well, the universe is everything, and if it's expanding, someday it will break apart and that would be the end of everything." At which point, his mother shouts at him, "What is that your business???"
What does this 1977 flick have to do with your question? Well, to borrow a phrase from Mrs. Singer, what is it your business that the stock market is going through a tough time in 2002? You're investing money for you won't need to touch for another 30 years or so, and even then it's going to be invested another 20 or more years as you draw on it during retirement.
You shouldn't be obsessing about short-term movements in the financial markets. You should be focusing on how you can get the long-term return you need to turn your twenty-five large into a decent retirement nest egg.
Good long-term returns mean stocks
And when it comes to that issue -- where can one find the best long-term returns -- I don't think there's much doubt that the answer is stocks, or given the amount of money you have to invest, stock mutual funds. Yes, things have been looking pretty bleak. But that's the way the financial markets work. Stock prices tend to go up most of the time and, occasionally, people get so hopped up about stocks that they drive their prices to absurd levels that the market can't sustain. That's what happened in the late 1990s.
But that's no reason to abandon stocks. We've had declines like this before and we'll suffer through prolonged setbacks again. But eventually markets bounce back, as long as the long-term underlying fundamentals of the economy are sound.
And I see no evidence that suggests that is not the case today. The economy hasn't exactly been sprinting out of the last recession. For all I know we may get a rare "double dip" -- that is, we may slip back into recession before mounting a full-scale recovery. But history shows that over long periods, stocks tend to earn significantly higher average returns than bonds and money-market funds.
Like any average, of course, stocks' long-term average return is made up of ups and downs. We're obviously in a down period now that has dragged down the average. But guess what: stocks tend to generate above-average returns when they come out of a downturn. Ironic, isn't it? When people feel most comfortable about buying stocks, like in 1999 when stocks were soaring, they're actually buying when the potential for future returns is lowest. And when people want nothing to do with the market, like now, their prospects for future returns are actually quite good.
But remember to diversify!
That said, there are no guarantees that stocks' future will be a repeat of the past. Which is why I believe in hedging my bets. Throw some bond funds into the mix. If stocks stink up the joint the next few years or longer, then at least one part of your portfolio will likely be churning out a return.
And don't own just one type of stock fund. Diversify. Hold several different funds so you have both large- and small-cap stocks and growth and value issues. For tips on how to set up a portfolio based on your risk tolerance and time horizon and for suggestions on fund you might consider, click here.
I'll leave you with one final pearl of wisdom from "Annie Hall." At one point, Annie Hall turns to Alvy and tells him that she doesn't think their relationship is working. Alvy replies, "I know. A relationship, I think, is like a shark, you know? It has to constantly move forward or it dies. And I think what we got on our hands is a dead shark."
Well, the U.S. stock market moves constantly too, sometimes up, sometimes down, but in the long-run the odds are extremely high that the movement will be forward. So what we got on our hands is a beaten-up market but not a dead one. I believe that long-term investors who buy now will be rewarded handsomely when it starts moving forward again.
Walter Updegrave is the author of Investing for the Financially Challenged and can be seen regularly Monday mornings at 8:40 a.m. ET on CNNfn.