Too scared to invest in stocks

(Money Magazine) -- Question: I'm a 32-year-old mom and the breadwinner in my family. I have no stomach for the stock market, as I feel it is akin to gambling. Can I still have a comfortable retirement without investing in stocks? --Kristen, Oxford, New Jersey

Answer: I agree that the way many people invest -- trading frenetically, hopping from sector to sector, chasing performance -- the stock market is a form of gambling.

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005).

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But if you follow a coherent strategy and hold stocks as part of a diversified portfolio, I'd submit that investing in stocks is nothing like playing blackjack or roulette.

That said, given the way the stock market has been behaving lately -- or I should say misbehaving -- I can understand your reluctance to pin your retirement hopes on equities.

But while I still think that stocks should play at least some role in the 401(k)s, IRAs and other retirement accounts of most people (and especially someone of your tender age), there's nothing to say that you can't exclude them from your portfolio. I mean, it's not as if the Retirement Investing Police will break down your door and haul you off to jail for violating the asset allocation statutes.

And for someone who believes the stock market is one giant crapshoot -- who simply gets too anxious watching its ups and downs -- there's a definite appeal to just saying no. If you stick to more stable investments like bonds or cash equivalents (Treasury bills, high-quality money-market funds, CDs, savings accounts and the like), you don't have to worry about the value of your retirement accounts nosediving because of a bear market.

But while avoiding stocks may make you feel better, there's a cost to shunning them -- namely, you're probably going to have to save a lot more for that comfortable retirement than you otherwise would.

To see how excluding stocks from your investing strategy might affect your retirement prospects, I revved up T. Rowe Price's Retirement Income Calculator. In the sections that ask for information about one's finances, I said I was a 32-year-old earning $50,000 a year who had already saved $25,000 for retirement. Since the calculator assumes you'll need 75% of your salary in retirement, my target level of retirement income in today's dollars was $3,125 a month.

After a bit of fiddling with the inputs, I eventually found that if I invested 70% of my current and future retirement savings in stocks and 30% in bonds prior to retirement and (assuming I'd want to be more conservative once I retired) 30% in stocks and 70% in bonds during retirement, I would have to save 12% of salary a year to have a 70% chance of generating my target retirement income. (This is assuming I retired at 65 and wanted reasonable assurance I would receive the income I need for at least 30 years after retiring.)

I then went through the same procedure two more times, first assuming I invested 100% of my portfolio in bonds prior to and during retirement and then putting the whole shebang in cash equivalents. To achieve my target income investing solely in bonds, the calculator estimated I would need to save 16% of salary annually. And if I put all my current and future savings in cash equivalents, it said I would need to save a whopping 25% of salary each year.

I don't know about you, but I think those differences could have a pretty significant effect on one's current lifestyle. For someone earning $50,000 a year, boosting your savings rate from 12% to 16% of salary translates to socking away an extra $167 a month. And going from 12% to 25% means stashing an extra $542 a month in retirement accounts. Remember, those amounts are on top of the $500 a month, or 12% of salary, you would already be putting away.

Keep in mind that these figures are projections, not guarantees. The actual amount you have to save will depend on the returns you earn over the coming decades. So to me the aim of this exercise isn't to come away knowing exactly what percentage of salary you need to save. Rather, the point is to give you a guideline for your savings effort, and to help you see the possible effects of different saving and investing strategies.

It's also important to remember that, while these projections do factor in stocks' volatility, they also assume that equities will continue to generate higher long-term returns than bonds and cash equivalents, as they have done historically. I think that's a reasonable assumption, despite stocks' spotty record of late. In fact, the more stocks are reviled, the better their likely future gains, as investors will demand a higher premium for taking the risk of investing in them.

Of course, if you're convinced that stock returns will lag those of bonds or cash in the coming years or that they won't provide enough extra return to compensate for the agita (or you just consider the stock market a giant casino) then you won't want to include them in your investing plans.

But even if you accept that stocks will generate higher long-term returns than bonds and cash, you should know that there is still a risk to including them in your retirement portfolio. As economist Zvi Bodie pointed out last year in Money Magazine, no matter how long you hold stocks, they will always carry the potential for sharp sell-offs. That risk doesn't go away.

I think you can adequately manage that risk by never putting all your money in stocks and by gradually shifting your stock stake into bonds and cash the nearer you get to the end of your career and then throughout retirement, which is essentially how target-date retirement funds work.

Bodie, conversely, advocates putting all one's retirement savings in investments that won't go down in value and that preserve purchasing power, such as TIPS and I Bonds. He also notes that to follow this strategy and retire by age 65, you would have to set aside upwards of 20% of salary each year, even if you're young.

So to sum up, yes, you can have a comfortable retirement without investing in stocks. But I don't think it's a viable strategy for most people. I think you would likely be better off devoting some, even if only a small portion, of your retirement accounts to equities.

But if stocks are truly anathema to you, you can get by without them. Just be prepared to do some heavy-duty saving.

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