From time to time, people ask why not invest 100% in stocks. This question is always met with astounding objections. People say
- it’s too risky
- very few will be able to handle the heat, i.e. most likely you will sell at the bottom
- inexperienced investors who haven’t been through a severe bear market are overconfident of their risk tolerance
- the thought must be misled by the recent run-up in the stock market
Someone on the Bogleheads investment forums collected the instances of people asking about 100% in stocks as a contrarian indicator of market tops.
These objections are legit, but I also noticed that Vanguard sets its target date funds at 90% in stocks for 15 years, from age 25 to age 40. Fidelity does it for 20 years, from age 25 to age 45. I had this chart in the article about Fidelity Freedom Index Funds:
90% in stocks is obviously not 100% in stocks. However, is there a big difference between 90% in stocks and 100% in stocks? If 100% in stocks is bad, is 90% in stocks that much better?
I looked at the peak-to-trough performance between October 2007 and March 2009. During this period, a 70:30 mix between US stocks and international stocks fell 55%. The Vanguard Target Retirement 2050 fund, which had 90% invested in US and international stocks plus 10% in bonds, fell 50%.
Having 10% invested in bonds helped, a little bit. Instead of seeing your portfolio fell 55%, you saw your portfolio fell 50%. Is that much consolation though? If someone would sell in a panic when their portfolio falls 55%, how is it going to stop them when their portfolio falls only 50%?
At 10% in bonds, the portfolio’s performance and volatility are going to be driven largely by the 90% in stocks. There’s no way that a small decoration such as 10% in bonds will make much difference. The decoration is there to plant the seed of the diversification concept early on. Even though it doesn’t do much yet in reality, it will be useful in the future.
If 100% in stocks is bad, 90% in stocks isn’t much better. Then why does Vanguard put people into 90% in stocks for 15 years? Is Vanguard being irresponsible or reckless? Does Vanguard know something we don’t?
It does. Vanguard has a lot more data than we do. It serves millions of retirement plan participants and millions of investors with IRAs and other accounts. It knows how much people make, how much they contribute, and how they behave during bull and bear markets.
Vanguard shares some of the data with us in its annual How America Saves report. According to the report, even during the chaotic 2008, only 14% of the retirement plan participants initiated any trades, half of which were buying stock funds instead of selling stock funds. The idea that everyone rushes out to sell when the market drops is simply not true, at least not true in retirement plan accounts.
Having 90% in stocks, or 100% in stocks for that matter, is also recognizing the difference between investing a lump sum and investing a stream of contributions over time. It is risky to invest 90% or 100% of a lump sum in stocks with no more new money coming in. Not quite so when you are investing a stream of contributions in the early years, when the vast majority of the contributions are going to be made in the future. Holding back early only means buying at higher prices in the future.
Let’s not kid ourselves in thinking there’s a big difference between investing 90% in stocks and investing 100% in stocks. Those who invest 90% or 100% in stocks aren’t necessarily overconfident inexperienced investors who are destined to sell in a panic at the market bottom. The vast majority actually hold it and add to it like clockwork. Vanguard has data to prove it.
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