4 Very Important Reasons to Save and Invest

William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Simply stated: People aren’t saving enough money. According to a recent article in Yahoo! Finance the average household only saved 3.9% of their income in 2012. Saving and investing have never been more crucial than in this age of disappearing guarantees.

What pension plans?

A generation ago people worked for the same company or at the very least in the same industry for most of their careers. Now, in order to lessen the burden on company profits, companies are freezing pension plans for some of their older workers and eliminating them altogether for new entrants into their workforce. According to an article by Investopedia, IBM froze its pension plan in 2006. Other companies such as Verizon and Lockheed Martin followed suit.

The National Compensation Survey put out by the Bureau of Labor Statistics provides a sobering macroeconomic perspective on defined benefit plans more commonly known as pensions. In 2012, only 26% of the workforce participated in a pension plan down from 28% in 2011.

Health care…maybe not

Statistics from the National Compensation Survey also point out the erosion of health care benefits on a macro scale with only 73% of the workforce having a medical card in their wallet, down from 74% in 2010. With the lessening availability of employer sponsored healthcare and the likelihood of paying for your own health insurance, the need to save for a medical emergency increases in urgency. Companies freezing or eliminating retiree health benefits and cuts in Medicare from our government also heightens the importance of building a medical nest egg.

Social security? Who knows?

In this age of ballooning deficits and political posturing in Washington D.C., retirement income in the form of Social Security seems more unlikely. In fact, I received a letter from the Social Security administration indicating that laws and benefits can change at any time. When planning for retirement it pays to operate under the assumption of no guarantees.

Extended unemployment or underemployment

With the average duration of unemployment lasting 35 weeks (see chart below) individuals need to save enough cash to last 2 years (italics added to emphasize importance). And, even if you snag a job within 35 weeks you need to prepare for underemployment, in case you find yourself working but only able to pay for part of your bills. The working American can breathe a sigh of relief with the recent improvement of the underemployment rate of 15.1% versus 17.3% a year ago, but it still presents a huge problem.

US Average Duration of Unemployment data by YCharts

How to prepare for an age of no guarantees?

First, an individual needs enough cash to live on for at least 1-2 years. Second, a person needs enough cash to provide health insurance and cover medical expenses in the event of the loss of medical benefits. Last, but certainly not least, when building enough cash for emergencies begin investing for retirement. To build a large enough nest egg to provide a decent income during retirement, you need the compounding power of the stock market which historically provided superior returns.

Stocks for growth

Investing in companies on a steep growth trajectory represents a riskier, but potentially more rewarding, route in building a retirement nest egg.

SodaStream (NASDAQ: SODA), maker of homemade soda machines, accessories and syrup grew revenue and operating cash flow 51% and 555%, respectively. The company’s stock price increased 39% beating the S&P 500 total return of 31% since going public in Nov. 8, 2010 (see chart below).

SODA Total Return Price data by YCharts

SodaStream capitalizes on increasing consumer awareness of health and environmental concerns. The homemade sodas from SodaStream sport less calories and don’t result in plastic bottles getting thrown into the environment.

The recent correction lowered SodaStream’s market price risk; however, the company still presents a certain amount of fundamental risk as it plows internally and externally generated funds into building an infrastructure that will enable it to compete effectively with larger beverage companies like Coca-Cola and Pepsi. However, if you can stomach the risk, this company has great potential in expanding your retirement nest egg.

Another company still growing in leaps and bounds, online mega retailer Amazon (NASDAQ: AMZN) grew its revenue and operating cash flow 283% and 302%, respectively, over past five years (see chart below). Shareholders enjoyed a total return of 272% during the same time frame.

AMZN Revenue TTM data by YCharts

Again, this company presents a degree of fundamental risk. CEO Jeff Bezos currently uses a huge amount of cash to build fulfillment centers in order to lower the amount of time from placing the order to receiving the package at your doorstep. In addition, Amazon consistently trades at a higher valuation, meaning the market scares easily with this stock. Any disappointment on Wall Street and the stock price of this company could suffer tremendously in the short term in which case you can swoop in and buy more shares.

Stocks for income

For people closer to retirement, companies that pay a healthy sustainable dividend will suit their needs. Companies with growing free cash flow and a dividend to free cash flow ratio south of 60% serve as ideal candidates.

Personal care products company Church and Dwight (NYSE: CHD) makes deodorant, toothpaste and laundry detergent. It increased revenue and free cash flow 6% and 24%, respectively, in 2012 and paid out 30% of its free cash flow in dividends translating into a 1.8% dividend yield as of this writing. Church and Dwight also possesses a small portfolio of products, making this company more nimble and easier to manage.

Food confectioner J.M. Smucker (NYSE: SJM) makes iconic branded products such as JIF peanut butter and Smucker’s jelly. So far in 2013, J.M. Smucker increased its revenue and free cash flow 9% and 96%, respectively. J.M. Smucker currently pays out 31% of its free cash flow in dividends, translating into a 2.2% dividend yield as of this writing.

Conclusion

In summary, with no guarantees of pension, health care, or social security along with the possibility of extended unemployment and underemployment, saving and investing have never been more crucial. People need to switch from a paycheck to paycheck paradigm to a balance sheet focus due to the increasing volatile nature of wages and income. After building cash for emergencies, attention needs to turn toward building a retirement nest egg by investing in quality stocks like the ones mentioned above. Only stocks can provide the compounding potential to help you retire.


William Bias owns shares of Coca-Cola but no position in any other stocks mentioned. The Motley Fool recommends Amazon.com and SodaStream. The Motley Fool owns shares of Amazon.com and SodaStream. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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