Does that sound like insanity? Or even irrational exuberance? It certainly hints at both. But based on the numbers, investing 100% in stocks until your 40 really can be the best investment strategy for young people.
The long-term trend is clear that stocks rise over the decades, even if they have a few bad years along the way. If you’re under 40, you have enough time to capitalize on the long-term uptrend, as well as to ride out the inevitable declines along the way.
Capitalizing on the long-term trend
Between 1928 and 2016 the S&P 500 had an average annual return of right around 10%. Few asset classes of any kind have come that close for so long. Meanwhile, the 88-year time frame covers a healthy human life span.
In any given decade, stocks can and do crash. If you have no more than a decade to plan for, you certainly wouldn’t invest 100% of your money in stocks. But when you’re under 40, you have several decades before retirement. That’s long enough to take advantage of the long-term trend in stocks.
Let’s say you’re 30 years old and you plan to retire at 65. That gives you 35 years to prepare for retirement. If you invest $10,000 per year, and earn an average of 10% annually, you’ll have more than $2.7 million by the time you reach 65.
By contrast, let’s say that you instead invest 50% of your annual contribution in bonds, with an average rate of return of 2%. At the end of 35 years, you’ll have $1.35 million in your stock portfolio and only about $250,000 in your bond portfolio. The total would be $1.6 million.
But by investing 100% of your money in stocks, you come out ahead by $1.1 million—$2.7 million versus $1.6 million.
This makes a lot of sense because you have 35 years to invest. By putting less than 100% of your money in stocks, you’re literally leaving money on the table.
Now to be completely fair, you probably will and should begin moving some of your money into bonds once you get within 10 years of retirement. That will reduce your final portfolio total somewhat. But you’ll still be way ahead as a result of being 100% in stocks for the first 25 years.
The built-in advantage of people under 40
100% stocks could prove to be a disaster if you need the money within a decade. But the built-in advantage that you have when you’re under 40 is that you have time to weather a bad run.
Even if the market experiences a crash of 50% or more that lasts for two or three years, you can still recover. Remember, the 10% average annual return on the S&P 500 since 1928 covers a time frame that includes the Great Depression, World War II, the Cold War, four outright stock market crashes (1929, 1987, 2000, and 2007), 9/11, and multiple recessions.
The decade-by-decade cumulative returns based on the Dow Jones Industrial Average since 1900 are below. Use them as a gauge to determine whether 100% stocks is a viable strategy:
- 1900s, +49.9%
- 1910s, +47.8%
- 1920s, +131.7%
- 1930s, 39.5% LOSS
- 1940s, +33.2 %
- 1950s, +239.5%
- 1960s, +17.8%
- 1970s, +4.8%
- 1980s, +228.3%
- 1990s, +317.6%
- 2000s, 9.3% LOSS
- 2010s, On the order of +250% through December 29, 2017
According to the statistics, there are decades when you can lose money with 100% stocks. That was certainly true in the 1930s and in the 2000’s, two decades that sustained major stock market crashes. We also see that stocks underperformed in the 1960s and 1970s. And the 1900s, 1910s, and 1940s showed no better than lackluster returns.
The most positive returns came in the 1920s and 1950s, but even more so more recently. The 1980s, 1990s, and the current decade have produced outstanding returns.
Moral of the story: if you can weather a decade of subpar returns, or even losses, a time horizon of at least 30 years will work in your favor.
Playing 100% stocks
Given that stock returns average 10% per year over the very long term, the choice here isn’t very complicated. You can simply invest in index-based exchange-traded funds, tied to the S&P 500. There’s no need to get involved in stock picking strategies, or even moving into sector funds. The trend of the general market is up over the very long term.
It’s not hard to see why. When you invest in stocks you are investing in the means of production. That means products, services, factories, office buildings, and even commodities. As long as the economy continues to grow over the long-term, which is the clear trend, stocks should benefit.
Once again, that doesn’t mean that they will turn in positive returns each year, or even every decade. But if you’re investing over several decades, the deck is stacked in your favor.
One caveat on 100% stocks…
Ironically, this may not be the best time for 100% stocks. There’s a well-used (and proven) saying that timing is everything. And so it is with the stock market. 100% stocks makes abundant sense in ordinary markets. But the market that we’re in now is anything but ordinary.
With the Dow Jones Industrial Average moving close to 25,000, the NASDAQ inching toward 7,000, and the S&P 500 closing in on 2,700, this is clearly an exceptional market. By all measures, the current stock market is richly priced by historical standards.
Warren Buffett has recently been credited with saying The market will go up, and the market will go down, though I’m pretty sure he’s not the first one to say that. But the point is well taken nonetheless. The stock market moves more like a roller coaster, and less like an elevator. That fact should never be ignored, current market optimism notwithstanding.
It may be best to be more conservative in this market environment, and “keep your powder dry” for better bargains on the other side of the current bull market. That means holding a decent amount of money in cash or short-term bonds. 100% stocks at or near a market bottom is the most effective way to build long-term wealth. 100% stocks at or near a market top is one of the best ways to lose it.
Investing 100% in stocks can be a risky endeavor unless you’re young and can handle the ups and downs of the market.
If you’re under 40, and the buying opportunity presents itself, be ready to go 100% stocks, and don’t look back.
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