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The 100% Stock Portfolio: Why Not?

Yesterday I asked what’s stopping a young investor who is very comfortable with volatility from investing in a portfolio consisting exclusively of equities?

A Valueless Economy?

Mark replied that the 100% stock portfolio would only be appropriate for the investor who is comfortable with the possibility that his investment drops literally all the way to zero. Call me crazy, but I truly don’t see that as a possibility if you’re invested in a diversified equity fund. Imagine–if you will–what would have to be happening in the economy for literally all the companies in the index to become valueless.

As far as I’m concerned, as long as our economy continues to produce profits, owning stocks will be a profitable endeavor if you have a long enough investing time frame. For example, if a company’s Earnings Per Share is $3, how low could the price of the stock reasonably go? Unless there’s reason to believe that the company’s earnings are about to drop, there will be a floor at which the price of the stock stabilizes based entirely on its attractiveness as an income investment due to dividend yield.

The same type of reasoning applies to our economy (and the world economy) as a whole. If our companies make money, owning those companies will be a profitable endeavor if we own them for long enough.

Now, having said all that, I must also say that I agree with the general point Mark is making: A 100% equity portfolio is only for the investor with a very high volatility-tolerance.

Diminishing Returns

Kyle replied that devoting a small portion of your portfolio (5-10%) to bonds would decrease overall returns only slightly, while going a long way toward tempering portfolio volatility. I haven’t yet run the numbers to see exactly how a 95% equity portfolio would have performed historically vs. a 100% equity portfolio, but I imagine that Kyle is right.

I would caution, however, against writing off the incremental return as insignificant just because it is small. Over an extended period of time, each percentage of additional return matters more than the previous percentage.

Example: A $10,000 initial investment growing at a rate of 7% over 35 years will turn into $106,766.

  • If it were to grow at 7.5%, the initial investment would turn into $125,689. (A 0.5% increase in return causes an increase of $18,923.)
  • If the money were to grow at 8%, it would turn into $147,853. (Another 0.5% increase in return, but this time it causes an increase of $22,164.)

I’m sure Kyle is right when he says that the incremental return from putting that last 5-10% of your portfolio into stocks isn’t very large. What I’m not so sure about is the insignificance of that incremental return (as small as it may be).

Does it make sense for you?

Obviously, a 100% stock portfolio isn’t for everybody. In fact, it’s probably only appropriate for a small minority of investors. But if you

  • have a very long investment time frame, and
  • don’t mind volatility even the slightest bit…

…then I honestly don’t see any reason why you shouldn’t be entirely in equities.

Update: Paul just put up a post at CrackerJack Greenback discussing a 100% stock portfolio–what it might look like as well as several noteworthy facts about how it would have performed historically.

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  1. I can answer your question about the difference between a 100% Stock portfolio and a 90% Stock portfolio.

    For the 100% Stock portfolio from 1927-2007:
    Geometric Mean Return = 11.4%
    Arithmetic Mean (Average) Return = 14.0%
    Standard Deviation (Measure of Risk) = 23.3%
    Highest Single Year Return = 83.4%
    Lowest Single Year Return = -50.3%
    Sharpe Ratio (Measure of Return per unit of Risk) = 0.43

    For the 90% Stock portfolio from 1927-2007:
    Geometric Mean Return = 11.0%
    Arithmetic Mean (Average) Return = 13.1%
    Standard Deviation (Measure of Risk) = 21.0%
    Highest Single Year Return = 75.5%
    Lowest Single Year Return = -45.3%
    Sharpe Ratio (Measure of Return per unit of Risk) = 0.43

    Not much difference if you ask me, but not that detrimental either. If that little bit of extra volatility really bothers you, go with the 90% Stock portfolio.

  2. Take a look at the Monetta Young Investor Fund.
    An all stock fund that is exceeding the return of
    the S&P 500 index by 10% this year. Innovative investment concept.

  3. Finance Frenzy says

    You do run a very large risk of not receiving any investment back at all if you are 100% in stocks. The last few years the stock market has been fluctuating significantly but really not going anywhere, causing some serious problems for people to be investing in the long run. The volatility of the market has been very disturbing.

  4. Do I think that the whole stock market will go to zero? of course not. I personally have most of my money in equities. But I do think that you can miss getting a return if stocks ever have another 10 year period like the past decade. Bond funds offer stable income during erractic times.

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