(MONEY Magazine) -- Question: My wife and are in our mid 30s and have begun aggressively contributing to our 401(k) and a Roth IRA. I know we should be looking long term, but it's discouraging that our account balances are lower than they were earlier in the year. If we had just stuffed the money under our mattress, we wouldn't be sitting on a loss. Should we keep investing in this market or go with the mattress theory? -- Daemon Fields, Eustis, Florida
Answer: I don't blame you for feeling discouraged. If you're serious about building a nest egg, it's hard not to feel disheartened these days.
After all, despite a rally since the end of August, stock prices are still down from their levels earlier this year, not to mention more than 25% below where they were nearly 10 and a half years ago.
So I can see why you might think that simply sticking cash under the mattress -- or, more realistically, investing it in something secure like Treasury bills or FDIC-insured CDs -- might be better than tying your retirement prospects to the stock market.
But I think you would be making a mistake to give in to the understandable urge to abandon stocks.
For one thing, when you're investing for retirement, you really do have to focus on the long term, and I mean really long term when you're only in your 30s.
To get an idea of why that's the case, let's take a look at an episode in U.S. stock-market history that's even worse than anything we've seen in our lifetime -- the Crash of 1929.
If you had invested, say, $1,000 in stocks when the market was at its peak in late August-early September of '29, you would have been sitting on a loss of about 83% by the time the market bottomed out roughly half way through 1932. In other words, your thousand bucks would have been worth only about $170.
What's more, it would have taken a long time for you to recover from that setback. Assuming you held on and reinvested dividends, you wouldn't have gotten back to even until the beginning of 1945.
But if you had held on until August of 1959 -- in other words, for 30 years, or about the same length of time you have from now until you and your wife will retire -- you would have earned an annualized total return of about 7.8% and your original grand would be worth just over $9,500.
Granted, had you invested in secure T-bills over that period, you wouldn't have lost any money in the crash. On the other hand, by the end of that 30 years, you would have earned only an annualized 1% or so, which means your original $1,000 would have been worth only a little over $1,300.
But this example shows only what would have happened to a single sum invested at one moment in time, that moment being the top of the market. When you're saving for retirement through 401(k)s, IRAs and the like, however, you're not investing all your money at once. You're periodically investing small sums. Which means you're effectively earning different rates of return on each 401(k) and IRA contribution.
Thus, while you would have earned 7.8% annualized on $1,000 invested at the top of the market in 1929, a $1,000 investment in stocks at the bottom of the market in 1932 would have earned an annualized 16% by August, 1959.
In short, over the course of a long career, you're going to earn a variety of returns on the money you invest, some lousy, some middling, some spectacular. You can never be sure what returns stocks will deliver. But as Ibbotson Associates founder Roger Ibbotson told me in a recent interview, the more fearful people are about investing in stocks, the higher the returns stocks are likely to generate going forward.
The point, though, is that I don't think it pays to get too caught up over the return at one particular point it time, whether it's fabulous or horrendous. What counts is how large a nest egg you'll eventually have to support you in retirement.
I want to be clear that I'm not trying to play down the risks of investing in stocks. They are definitely risky. Stock prices can fall precipitously and they can stay down for a long time. And even though history shows they have rewarded investors handsomely over long periods, those returns are anything but certain.
That's why, even if you're OK with the case for investing in stocks over the long run, your retirement portfolio shouldn't be invested entirely in stocks. You also want to be sure to scale back your stock stake as you approach retirement -- and continue doing so after you retire -- to avoid seeing your savings get decimated late in late in life when you don't have as much time to recoup losses. That's the theory behind target-date retirement funds.
Of course, you could chose to build a nest egg without stocks by investing solely in more stable alternatives like bonds and cash equivalents. But as I showed in a recent column, you'll have to save a heck of a lot more money during your career if you want to live decently in retirement.
So as I see it, you have a choice. You can do the investing equivalent of keeping your money under your mattress and avoid stocks. Or you can take what I consider a prudent level of risk and include stocks in your long-term retirement investing strategy.
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