According to a recent article in Market Watch the folks who have buying up stocks faster than anyone else in the last thirty years are those making family incomes of $42,000 a year. Why is that?
What’s changed since 1989? Access did.
Specifically, access to workplace retirement savings plans, like 401(k)s, and personal investment accounts, like IRAs.
Individual retirement plans in the USA hold about $9 Trillion and 401(k)’s hold about $5 Trillion. The entire US stock market has a capitalization of about $30 Trillion. And, since so many of us now have these tax-deferred vehicles, how should you invest your retirement accounts?
Long Term and Smart Investing for Retirement
Invest for the Long Term
The key to investing your 401(k) or IRA is to remember that the money will be for retirement. By waiting until retirement to take any money out of these vehicles, you will likely pay less in taxes because your income will be less than during your working years. And, of course, any capital gains will be long term because many of your investments will be ones that you have held for years.
Use Intrinsic Value as a Guide for Investments
Since you will be picking investments that you may well stay with for decades, we suggest that you take a couple of clues from perhaps the best long term investor, Warren Buffett. Buffett invests in the US stock market because its growth is tied to the growth of the US economy. He only invests in stocks when he has a clear understanding of how they make money and how they are likely to continue to do so for years and years. He was also a pupil of Benjamin Graham, the father of value investing and originator of the concept of intrinsic stock value. Thus, all of his investments are limited to stocks with a substantial margin of safety and the potential for healthy long term growth. U.S. News writes about Buffett in an article about why Buffett is a better investor than the rest of us.
Take Advantage of Tax-Deferral
There are companies that have been paying dividends for decades or ever for a century. Many investors simply have their dividends automatically reinvested. But, outside of your IRA or 401(k) you have to pay taxes on the dividends. But, when you buy these stocks for your retirement accounts, those reinvested dividends are not taxed until you withdraw from the account.
The Street lists 16 stocks that have been paying steadily increasing dividends for 50 years.
- Coca Cola
- Johnson & Johnson
- Procter & Gamble
- Genuine Parts Company
- Dover Corporation
- Emerson Electric
- Parker Hannifin
- American States Water Company
- Cincinnati Financial
- Lancaster Colony
- Nordson Corporation
- Northwest Natural Gas
- Vectren Corporation
How you should invest your retirement accounts in these stocks is to learn about the companies that interest you. Do they dominate a huge market niche like Coca Cola does or are they a somewhat protected business like a utility with reliable profits year after year? Buffett has been quoted as saying he avoids tech stocks because he does not know what they will be worth in five years. But, he says that as an example he has a pretty clear idea about what a Snickers bar will be worth and that people will be buying them. The point of looking at this list of dividend stocks is that it tells you the company has been successful over the long term, which probably indicates they will remain successful during the years that you own their stock.
How Should You Invest Your Retirement Accounts: Diversification
We all wish that we had purchased a few shares of Microsoft when it went public back in the 1980s. The stock today is hundreds of times more valuable, taking stock splits into consideration and the dividend is many times the original value of the stock. If you had just purchased reliable dividend stocks back thirty years ago, you would have missed out on Microsoft.
The fact of the matter is that nobody, including Buffett, is perfect at picking investments or timing the market. That is why smart investors diversify their investment portfolios. Investopedia writes about the importance of diversification.
Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries, and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event.
Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk.
The aim is to invest in various assets so that they will not all be affected the same way by market events.
In general, investors think about interest rates, the economy, and the like when diversifying. However, this approach guarantees that you will miss out on the next Microsoft! Somewhere among the many biotech startups there are a couple of companies who ideas and products will change the world. Today there are already treatments for cancer that were not even though of just a few years ago. When the cures for diabetes, Alzheimer’s, and other devastating diseases come down the pike, those who invested early will do very well. Picking the right stock is difficult, but there are index funds that allow investors to put a few dollars into sectors that may pay off a thousand fold due to the accelerating advance of science.
The point of diversification is to reduce your risk from any specific investment and open opportunities for a big winner from an unexpected source. How you should invest your retirement accounts is to follow the advice of pros like Buffett, stay in the market for the long term, learn and apply the concept of intrinsic value, and diversify.