Administrative note: I’m thrilled to be back to working on articles after an enjoyable and productive break. At the same time, having had two weeks to reflect on it, I’ve decided to change the schedule to just two articles per week — basically the same as for the last few years, minus the Wednesday article. The point of the change is to free up more time to work on updating existing books and creating new ones — something that I haven’t been able to spend a sufficient amount of time on so far in 2013, as readership (and therefore volume of reader emails) has increased.
A reader writes in, asking:
“I recently inherited nearly $200,000. I’m 25 and am new to investing, but I’m reading everything I can to make sure I don’t squander this opportunity by investing it poorly. Based on what I’ve read, because I’m young and because I now have plenty of ‘cushion’ I can use a risky asset allocation. Is there any reason I shouldn’t go 100% in stocks?”
An all-stock allocation can make sense in the right circumstances:
- You want to take on lots of risk in the hope of higher returns,
- You can afford a large decline in the market, even if that decline is not followed by an immediate comeback, and
- You have good evidence that you won’t panic and sell during a sharp market decline (or, the size of your retirement portfolio relative to your total economic assets is small enough that it’s no big deal if you do end up panicking and selling at the bottom of a bear market).
Stated differently, you must want to have a high-risk portfolio and you must have the economic and emotional risk tolerance to handle such a thing.
In addition to being able to satisfy requirements #1 and #2, many young investors can satisfy requirement #3 because their portfolios are small enough that even if they do capitulate and sell during the next bear market, it’s no big deal for their long-term financial success. They (permanently) lose a little money, but in the process they gain valuable information about their risk tolerance — not a wholly bad experience.
But for anybody with a significant amount of assets on the line, it doesn’t make sense to use a high-risk allocation unless you have evidence that you can handle such a level of risk. And the only way to have such evidence is to have actually made it through a real-life bear market without selling. (And this is why, if I were in the above reader’s shoes, I would not personally want to have an all-stock portfolio.)
Further, for that previous bear market experience to be particularly meaningful, it must have been under economic circumstances that are at least roughly similar to your current circumstances. In other words, if your portfolio is now many-times larger than it was before the last bear market or if you’re now retired whereas you were still working during the last bear market, knowing that you didn’t panic and sell last time doesn’t necessarily tell you very much about what you’ll do this time.