Circulating like a horsefly at a barbecue is this notion that an all-equities financial portfolio is the best way to maximize your investment dollars.
Proponents make a straightforward claim: Since stocks are the best-performing long-run asset class, you’d be a fool to place your funds in anything else.
It’s true that stocks tend to outperform other assets over the long haul. And it’s absolutely the case that, if left on autopilot, an all-stock portfolio would usually leave retirees better off than other allocations over many years.
That’s all well and good. But it’s also profoundly disturbing. Because, for the unprepared investor, prescriptions like this are more problematic than waking up with your forehead superglued to a toilet.
For those equipped with the requisite knowledge and strategy, however, the all-equities approach just might be worthwhile.
In this edition of don’t-burn-your-financial-house-down, we’ll bat around the following:
What the all-stock portfolio is.
Its pros and cons.
Who it can work for, and who it can’t.
Why a Luchador might consider all-stocks, and how I use the strategy in my portfolio.
En flambé is this: To maximize your portfolio’s total size over the long term, there’s no better bet than equities. Hence, your entire portfolio should be 100% in stocks.
No cash. No P2P loans. No real estate. No plastics. No nada pero stocks. Diversification equals zero, save for whatever mild diversification benefits can be achieved by spreading your stock dollars far and wide.
In fact, some advocates of the approach tell us that, to really milk the teat of mama market, younger investors should actually be as much as 200% in stocks.
For those of you scrambling to find the old TI-85 to figure out how we can invest 200% of 100%, I’ll save you the trouble. The practice entails leveraging your portfolio’s holdings either via margin accounts or by executing certain options strategies that synthetically leverage a portfolio.
We’ll maybe kick this leveraging concept around another time. But for now, let’s just stick with 100% in stocks and recognize that, for as aggressive as 100% may sound, it’s actually kind of a middle ground position for a lot of theory-heavy finance dudes.
Note: Advocates of high/all-stock allocations and portfolio leveraging include very serious finance bros Ian Ayres and Jeremy Siegel, so we’re not just talking about weirdos who hang out in their mom’s basement all day drinking Fanta and tricking out old Atari consoles. Probably.
Moreover, even when we set aside the theoretical argumentation, there remains a real-world consideration that pulls an all-equities portfolio into the realm of consideration for the average American:
“The sad reality is that Americans are so woefully unprepared for retirement that they need to be aggressive if they have any hope of retiring at all.”
The same article that’s quoted above cites a 2014 Bankrate survey showing that, even among Americans aged 50 to 64, more than 25% hadn’t started saving for retirement yet.
“Yeah okay,” you say. “I get that stuffing stocks into the account maxes out long-run results. Those long-term geometric average stock market returns of over 8% sounds pretty tantalizing. And if I’m one of those sorry fools who hasn’t begun setting aside funds for retirement by the time I’m 55, I might have no choice…But it’s super-risky, right? Couldn’t I lose it all?”
Advocates will say: You probably wouldn’t lose it all, even in the worst of worst cases. When the market crashed in 1929, investors only suffered about an 85% inflation-adjusted loss through mid-1932. Which is about as bad as things could ever get.
You: Only 85%? That sounds about as pleasant as getting impaled by a rhinoceros.
Advocates: So, okay, the worst-case scenario is pretty rough. But not a complete loss. In more recent times, the nastiest sort of equities value drop we’ve seen is only around 50% of value. This occurred in connection with the ’08-’09 crisis.
To which advocates would add: If you’ve got a long-term investing horizon, those dips will be long-distant memories by the time you need to cash out. And it’s that volatility for which you’re being compensated with world-beating returns. After all, it takes just a few years of average market growth to make up for that 50% loss. Which, in actuality, is what happened.
Me: So, they tell us, what sounds risky initially is actually the safest bet to maximum long-term nut size.
You: But still, FL. Even if only a third of your portfolio (let alone half) got wiped out, it would hurt worse than getting brained by the side mirror of an SUV drifting into the bike lane.
Me: Yeah, okay. Advocates would have to admit there’s still plenty of risk in so-called normal periods that would suck to experience, long term or not.
And that brings us to one all-stocks problem that’s as big as Shaq’s Gold Bond collection. It’s this whole long-term issue.
Let’s get the terminology straight first. “Long term” means a whole slew of different things in different contexts. In SEC filings and tax accounting crap, “long term” means more than a year. In pop music, it’s anything over 4 minutes. In financial planning, it’s more like 10 years plus.
This 10-year-or-so horizon is what we’ll call our “long term problem.”
Basically it boils down to this. The stock market can be depressed for mega-protracted stretches – periods that are even longer than long term. And anything above 10 years is kind of a bummer for early-retiree Luchadores. It’s an equally serious bummer for the 55-year old who goes all-in to equities and gets decimated by a market fall just before planned retirement.
Look at what happened during the Great Depression. In August 1929, the U.S. stock market’s Dow Jones Industrial Average index peaked at $5,212 (in inflation-adjusted dollars; at around $380 not adjusted). That level wasn’t maintained again until the 1960s. Even ignoring inflation, nominal value didn’t get back to pre-Depression levels until 1955. (To play around with these numbers, check out this groovy interactive chart from Macrotrends.net.)
That’s more than a quarter of a century!
Then, following the peak value attained in December 1965, the Dow weathered another 30 years of doldrums and inflation-adjusted loss until getting back to even in the mid-1990s.
Don’t you just love it when two statistical truths seem incompatible?
Well, it brings to fore two points. First, the DJIA 30 is a terrible stock index for purposes of understanding the broader market. Second, the no-lose 20-year all-stock portfolio has had some pretty close calls.
The never-lose-over-20-years stats use S&P 500 total returns rather than the Dow, and they assume reinvested dividends, no taxes and no transaction fees. The no-loss story also is generally reported ignoring the effects of inflation.
If inflation’s built into the analysis – which it always should be – the headline stays the same, but overall returns aren’t quite so rosy. In other words, no portfolio ever would have lost, but some would barely have stayed even with price increases.
With taxes and fees, at least a few instances of below-zero returns would result.
When investing horizons get shorter – say 10 years or 5 – the likelihood of winning with all stocks falls. Over a 10-year horizon, you’ve still got a great chance of beating inflation. But you could also lose. At 5 years, you’re playing with fire. Over these and other “short-term” investing horizons, portfolios would often perform better if balanced across multiple asset classes.
So the long-term problem means, if we’re 100% in equities, we’d better settle in for a long, long haul – at least around 20 years to guarantee we don’t get burned. And we really need to keep an eye on taxes and fees along the way, not to mention our own psychological tendencies to buy and sell at the worst possible moments.
All of which is maybe okay for some. But for firm-fleshed Luchadores, who might aim to enter the realm of retirement in their 30s, we demand better.
Yes, we Luchardores want to maximize our returns, but we don’t want to lose all our hard work just for a couple extra basis points.
Which now brings us to the part of our story where you, fair Luchador, have basically decided you know what to do. Here’s what you’re thinking:
Juicy stock returns nummy.
Scary stock price falls scary.
Always stay diversified.
Which, yes, is why FL espouses a balanced approach to portfolio allocation, using low-correlation assets nestled among fuerte stocks to provide returns and safety.
After all, with a portfolio allocated, say, 75% into stocks, you’re only missing out on equities-powered returns on ¼ of your dollars. All those non-stock holdings are still providing returns and utility in physical real estate, REITs, P2P loans, opportunistic “alternatives” and other goodies. They’re also tamping down volatility and enabling valuable rebalancing along the way.
Which is why, in the mind of this Luchador, a 100% stock allocation is not only unduly risky but also not substantially more profitable than a smartly diversified one. This goes for the 25-year old early-retiree spiff as well as the 55-year old standard-retiree stiff.
Notwithstanding this FL-styled flying-elbow-to-the-skull of the all-stock portfolio, one more popular type of portfolio allocation is even worse. The conventional guidance of a 60/40 stocks/bonds split, or any similar allocation heuristic that 1) ignores various asset classes and 2) underexposes the investor to stocks is no better than an all-stock allocation. And, over the long run, or even the not-so-long-run, such allocation would almost certainly be much worse.
Why? Bonds exhibit real returns flatter than the Nebraska plains over the long run, while other asset classes climb the Rockies. And you don’t need bonds to appropriately diversify your portfolio. This chart summarizes long-run real returns (i.e., net of inflation) for a slew of asset types. The only thing worse-performing than government bonds would be a house built of gold.
The Crispy Treat
You say: Okay, FL, we get it. We get it. Don’t go 100% stocks. More like 75% is good. But you said something about the all-stock allocation working in some instances, including yours… What gives?
Here’s who the all-stock allocation could work for:
Wee youngsters with at least 20 years to go before they’d need the funds.
Non-Luchadores who plan to work until their souls rot from sheer tedium; that is, for at least another couple decades.
Risk-seeking individuals for whom good returns are simply a nice by-product of an enjoyably volatile ride.
Luchadores who have funds sequestered in tax-advantaged retirement accounts.
Let’s address this last point since that’s where my all-stock allocation “portfolio” resides: in an IRA.
For clarity: The Libre family does not have a 100% stock allocation. Never have. Never will. It’s not necessary for great returns, and it introduces more risk than it’s worth.
But, within our two IRA accounts that inherited former employers’ 401(k)s and the retirement funds set aside from our entrepreneurial ventures, we are 100% stock allocated*. Such allocation is likely appropriate for most investors who don’t intend to tap retirement account funds for many years. (*Note: Here, I am considering REITs to be stocks since the distinction between REITs and non-REIT stocks, from an investor’s perspective, is very minor. We do have some REITs in our IRAs.)
The benefits of all-stocks (including REITs) in retirement accounts are myriad:
Stocks spin off dividends, which incur taxes in non-protected accounts but don’t in IRAs and 401(k)s.
Stocks grow faster than pretty much all other asset classes over the long haul.
Stocks don’t provide tax advantages for most investors the way physical real estate or business ventures or other investment vehicles can when held in non-tax-deferred forms.
This latter point means that tax-advantaged vehicles don’t have a place in tax-sheltered retirement accounts since you can’t “double-up” tax benefits – you lose one or the other (e.g., the depreciation benefit on a rental real estate). Which leaves only non-advantaged vehicles like stocks, bonds, P2Ps, etc. for consideration in our IRAs. Which means we just want the fastest grower over the long term in the IRA accounts.
Which is stocks (and REITs).
Which means basically going all-in 100% stocks all the time in IRAs and 401(k)s for the Luchadorians among us.
So what to do about all this?
First, get your IRAs and 401(k)s in order.
Consider going all stocks in these types of accounts, so long as you don’t plan to tap any of the funds for a long while.
But bear in mind, if you’re going to be a “first-time homebuyer” soon, you may want to use some of your IRA funds to assist with a down payment. In which case, you may want to set aside up to $10k outside of stocks until then.
Otherwise, so long as you don’t plan to tap the funds before the early-withdrawal penalties expire (which are ruinous, so best to be avoided), all-equities is a reasonable choice.
Second, get cozy with your overall portfolio allocation.
There’s another way to take advantage of IRAs and 401(k)s that might make sense for Luchadores.
Specifically, it entails housing lots of your least-tax-advantaged assets in tax-advantaged accounts as part of your overall portfolio planning.
Dividend stocks, P2Ps and REITs all can be easily placed into tax-deferred accounts, which is especially salutary for long run growth since these investment types all spin out lots of income that would otherwise be taxable. Dividend stocks and REITs are especially useful in this capacity because of their high rates of return and the large proportion of their total returns in income.
Simply recall: Should any funds or income be needed from these assets before withdrawal penalties expire, they do not belong in a long-term account like an IRA.
Until next time, Luchadores, tell me what you think of the all-stock allocation strategy, whether you’ve ever used it, and whether you ever will.
Theme by MyThemeShop.
Unless you've been living in a cave and receiving FinanciaLibre updates solely by smoke signal and carrier pigeon, you already know what this is going to say. FinanciaLibre is a blog. On the Internet. It can't be trusted to provide answers to all life's troubles. It won't un-click the buttons on your keyboard or cellphone when you're making a ridiculous error. It's only here to entertain, provoke, motivate and, from time to time, inform. You're the captain of your own financial dinghy. Not FinanciaLibre. FinanciaLibre does not provide financial advice, legal advice or medical advice. FinanciaLibre is not a certified public anything. It's not a religion. It's not even a real word. Your decisions, actions, victories and losses are your own. FinanciaLibre's not responsible for anything you say, do or eat. Own your decisions, Luchadores.