Save a million dollars: Buy stocks

Despite the enticing headline, let me forewarn that I won’t promise you that you will get rich, and I certainly cannot promise that it will be quick. What I will try to explain is why you should think about investing in stocks.

You won’t get rich tomorrow. Long-term investing in the market is a strategy for wealth accumulation that will probably take many decades, so I have more of a “get rich slowly” strategy.

Stocks have proven, over the long run, to be one of the most prudent investments for someone who wants to accumulate wealth for retirement.

Stocks have had compounded annualized returns of 8.3 percent for the last 200 years, according to Wharton School of Business finance professor Jeremy Siegel in “Stocks for the Long Run.” Stocks have kept up with inflation, so any money you invest in stocks will probably not be devalued by rising prices.

According to Siegel, $1 invested in the total stock market in 1801 would be worth over $8.8 million in 2001. This calculation assumes that all dividends would be reinvested and compounded.

Investing $100,000 in the stock market when you are 35 would turn into $1,093,588 at a rate of 8.3 percent compounded annually for 30 years. You would be a millionaire by the time you retire, but this calculation does not assume any investment before you are 35.

Even if you started investing a small amount when you were 25, you could eventually accumulate a lot more.

Of course, this calculation assumes that the stock market would return 8.3 percent annually, as it has historically, but unfortunately no one knows what the future returns of the stock market will be.

Stocks have handily beaten the returns of savings accounts, bonds and even gold over the long run. The reason for the discrepancy between the returns of stocks and fixed income investments like bonds is the risk involved in each investment. Stocks are a lot riskier than bonds and savings accounts, so a higher return must be rewarded to the investor to purchase stocks in the open market.

Plus, stocks benefit from the earnings growth of companies. For example, companies in the S&P 500 – an index containing the stocks of 500 mostly American corporations – have had earnings growth in the double digits over the last few years. The robust growth of companies over the past few years, and certainly the past few decades, has benefited shareholders with significant returns.

If you are adverse to risk, stocks may not be the right investment for you. Bear markets – prolonged periods where market prices are falling – do exist, and they have destroyed significant amounts of shareholder wealth. The last bear market, the technology bubble in 2000, not only saw the 70 percent decline of the technology heavy NASDAQ index, but large declines in the S&P 500 and the blue chip Dow Jones Industrial Average after that.

However, this bear market was unique in the rampant speculation of internet stocks that had no earnings and only the optimism and dreams of investors to keep them afloat. This speculation brought with it a relative overvaluation of the entire stock market, where stocks were trading at much higher levels than they had historically.

The stock market is risky, that is why it has been so rewarding to so many investors and so cruel to others. But with a prudent, long term strategy, you could see significant wealth accumulation.

In “Stocks for the Long Run,” Siegel calculated that the stock market returned positive compound annual returns over any 20-year period for the last 200 years. That is a pretty damn good track record. Of course, this data assumes that all dividends are reinvested to purchase more shares of stock.

Empirical data like Siegel’s shows that a long term stock investor could beat bonds, as long as he does not withdraw his money at any sign of pessimism.

There is also an important caveat for the long term, value-oriented investor. An investor who buys when the market is bearish and buys less when the stock market is fully valued or overvalued will see much greater appreciation in his wealth than someone who sells during a bear market and buys when optimism is at a high – as many people did during the technology boom.

I know retirement is a long time away, and it is something you probably do not want to think about. However, by investing early, you have the greatest potential for significant savings because of the power of compounding.

The same thing goes for investing in stocks, but there is an even greater incentive to save because there is the potential for greater amounts of compound interest. That is why it is important for you to establish 401k accounts and Roth IRA accounts.

The past may not dictate future performance, but what the past shows us is that stocks have been one of the best investments over the last 200 years. In the end, history has to count for something. I don’t recommend putting all of your money in the stock market, but you should definitely get at least some exposure.

Information from – “The Only Investment Guide You’ll Ever Need” by Andrew Tobias