Should Young Investors Be 100% In Stocks?

Earlier this week, Mike at The Oblivious Investor wrote a post entitled Asset Allocation For Young Investors, Go “All-In?” in which he postulated that since stocks have historically been the highest-performing and most reliable asset class over the very long term, it makes sense for young investors with at least 30 years of investing ahead of them to be 100% in stocks.  Most experts, on the other hand, recommend even young investors be at least 5-10% in bonds (I’m 10% bonds, personally).

As a comment on that post (there are several good ones, check it out) I offered up a plausible reason for never going 100% stocks, namely due to the law of diminishing returns.  While adding more and more stocks will increase returns over the long term, once you get past a certain point, perhaps around 80-90% stocks, the incremental return begins to be outweighed by the additional volatility.  Thus, a 10% bond stake can be seen as a cheap insurance policy since it decreases returns only a slight amount but decreases volatility significantly.

The Numbers

I was going to run the numbers myself, but as it turns out JLP of All Financial Matters has already done that.  His results are interesting.  Over the period 1926 - 2006, a 100% stock portfolio would have returned 10.42% per year while a 90/10 split would have returned 10.10%, or a 0.32% per year difference.  Of course, 0.32% per year is pretty big over an 80 year period, but what about a more reasonable time-horizon of 30 years?

Over the 30-year period ending 2006, JLP found the performance spread between a 100% stock portfolio and 90/10 portfolio to be a narrower 0.22% per year.  Assuming you started with $10,000, the 100% stock portfolio would have an ending balance of $413,344.38 and the 90/10 portfolio would have an ending balance of $387,204.88, or about $26,000 less.  That’s not an insignificant sum by any means.  The problem is, the data shows time periods as long as 10 years in which the 90/10 portfolio actually out-performs, so this out-performance isn’t guaranteed.

The conclusion?  If you are a risk-taker, there is nothing wrong with a 100% stock portfolio.  Over the very very long term (30 years at a minimum) you will likely out-perform a slightly less-aggressive portfolio.  That said, your out-performance will probably be much less than you may have expected.  Also, keep in mind that JLP found the 90/10 portfolio to be much less volatile than its 100% stock cousin.  In essense you are trading a great deal of certainty for a small incremental return.  If you’re comfortable with that, so be it, but go in with your eyes wide open.