Monday, September 20, 2010

Defending the All-Stock Portfolio

It's not hard to find people who criticize the idea of investing a portfolio entirely in stocks. They often make some very strong points in favour of including some fixed-income investments in a portfolio. My purpose here is to defend the all-stock portfolio for the right investors.

Let me start by saying that an all-stock portfolio is not for everyone. In fact, it probably only makes sense for a small minority of investors. The arguments commentators make against an all-stock portfolio effectively identify people who shouldn't own 100% stocks.

Let’s look at some of the pros and cons of an unleveraged diversified portfolio of all stocks.

Pro: Over the long run, stocks have outperformed bonds.

This is the only important advantage of stocks over bonds. Over long periods of time, stocks have consistently outperformed bonds. The hope is that this will continue. There are good reasons to believe that it will continue. People tend to be risk-averse and will demand a higher return for accepting risk.

Con: Stocks can crash and take years to recover.

This is true. However, for stocks to continue to outperform bonds over the long term, the period after a stock market crash must have large enough stock returns to offset the crash and overcome the steadier bond returns. But this only helps the investors who stay the course. If an investor panics and sells, he or she will miss out on the recovery. There is no guarantee that the recovery will come quickly, but recoveries have always come along eventually.

The recent stock market crash in 2008 and 2009 was a good test of investors’ temperament. Author Derek Foster was well-known for advocating stock-based investment strategies, but lost his nerve and sold at a bad time. This shows that even apparently knowledgeable and experienced investors can find that they don't have the temperament for an all-stock portfolio. Foster would do well to balance his portfolio with some fixed income to avoid a repeat of his costly mistake.

This period was a good test for me as well. I’ve lived through more minor stock market declines, but this was a big one for me. Fortunately, I passed. I spent the time I devoted to investing gathering my nickels to buy more stocks rather than biting my nails while wondering when I should sell out.

Con: During market declines, withdrawals can decimate a stock portfolio.

This is very true. It makes no sense for retirees or anyone else who needs to draw on their portfolios for income to be 100% invested in stocks. This can even apply to people who might need to make withdrawals. If losing your job during a market decline is a possibility that will lead to drawing on your long-term savings, you should consider allocating some of your money to something less volatile than stocks.

As a rule of thumb, investors should consider safe investments for any money they might need in the next three years. More conservative investors may choose five years instead.

Con: The high volatility of stocks keeps investors up at night.

A decent night's sleep is important. It makes little sense to live in fear. Each investor has to choose a level of volatility he or she can live with. However, don't delude yourself. Over the long run, GICs have had significantly lower returns than stocks. If you make a choice for calm over the potential for higher returns, this might be the right choice for you, but it won't change the fact that you are very likely to underperform stock market indices over the long run.


Most people are not good candidates for an all-stock portfolio. It may even be true that most people who think they are good candidates for an all-stock portfolio really aren’t. It’s hard to know how you’ll react to market declines until you live through them. The recent crash of 2008 and 2009 should have given you some clue about your investing personality. If you confidently ignored all the doomsday talk of the death of stock investing, you may be a good candidate for an all-stock portfolio. If you got caught up in all the negativism in even the slightest way, consider a less volatile portfolio make-up.


  1. Your guidance on investing is very formulaic. There are better ways to run an "all-stock portfolio".

    Why not look to successful investors such as Seth Klarman of the Baupost Group (24% annualized for 25 years) or Warren Buffett (25% annualized for 40 years). They all strategically hold cash as an asset class to take advantage of opportunities.

    I put a lot of money to work in October 2008 and March 2009 and moved to an "all-stock portfolio". It takes a different gameplan than just saying -- I'm investing in stocks. Having cash reserves when being a stock-only investor is a tenet of success. Cash when others have none is very valuable.

  2. @Anonymous: I used to try to emulate wildly successful investors such as Warren Buffett. I've come to the conclusion that I can't do it. The truth is that the vast majority of those who try to emulate the most successful investors fail miserably. By "fail" I don't just mean that they don't do as well as these successful investors, but that they underperform the stock market indexes badly. I expect to outperform more than 90% of investors (over 2 or 3 decades) by just buying and holding low-cost stock indexes. I'm content with this.

  3. @Dale: There is an echo generation coming along (with medain age about 21 right now). As boomers draw on their savings, their assets will transfer to this next generation. I don't have a crystal ball and I'm sceptical that predictions based on demographics give perfect insight.

    1. The comment above is a reply to Dale Rathgeber's comment:

      Another con is the demographic shift whereby the baby-boomers who fed the run-up of stock markets in the 90s can shortly be expected to become more conservative --(investing in fixed income to a greater extent, thereby lessening the demand for equities). The flat 1st decade of this century may already be explained in part by this phenomenon.

  4. @CC: I agree. Parking money on the sidelines waiting for a great opportunity sounds good, but great opportunities are rare. There is no guarantee that this approach will beat just buying and holding.

    1. The comment above is a reply to Canadian Capitalist's comment:

      There is a downside to what Anonymous is proposing. You can't predict when crashes will occur and most people don't have the patience to wait for a perfect opportunity. Therefore, a formulaic approach to investing ain't necessarily a bad thing.

  5. I have a defined benefit pension through the public sector, and for my personal investment strategy I choose to have an all-stock portfolio. I am ok with not being overly diversified because I will use the DBP to fund my retirement and I won't be selling the stocks, just withdrawing dividends.

  6. Great article Michael.

    I myself, am a fairly junior to dividend investor - I haven't lived through many big downturns. Rather, I started "getting in" during the most recent downturn.

    I think if I saw the market tumble by 50%; to be honest, I don't know what I'd do. Maybe sell like Derek, I don't know. I know a couple of my stocks earlier this year dropped by 20% and I didn't even think of selling. Over time, it will be interesting to learn where my personal breaking point is.

    I would agree, most folks are not good candidates for an all-stock portfolio; maybe I'm not. Saying you won't pull-out is one thing; actually not doing it is something totally different.

    At least with your index strategy, you're guaranteed market returns.


  7. @Echo: It's true that even for those who are somewhat risk-averse, an all-stock portfolio can make sense when you're backed up by a solid defined-benefit pension.

    @Mark: You're right that you can't be sure how you will react in the face of large losses until you experience them. I passed the 2008-2009 test, but who knows what the future holds.

  8. As you may be aware, my portfolio is the mirror image of yours. I have zero stocks, zero bonds, a lot of cash, and a small short position via an inverse ETF. Having said that, I believe you made an excellent argument for why you're 100% in stocks. Unlike many investors, you have a well thought- out plan. You know what you're going to do in any scenario.

    Most importantly, you understand your investing personality and you're comfortable with your risk level. I am curious, however, about what your plans are as you get closer to retirement. What will your allocation look like at age 65 or so?

  9. @Balance Jumkie: I don't have a clear idea yet of what age both my wife and I will fully retire, but when I think it could possibly be 3 years away, I'll start creating a fixed income position (cash, GICs, or short-term bonds). Rather than allocate a fixed percentage to fixed income, I'll be guided by what I think I'll need in the following 3 years.

  10. I think this is a good post, but you could have done some formatting to support your position (which I agree with).

    You should have put the pro in 25 pt font, bold. The cons should have been 4pt font, dark white on a light white background.

    I'm exaggerating, of course, but it is a valid point that the one pro, in your opinion, outweighs the three cons, even though the cons get more virtual ink in this blog post. That said, I wouldn't feel right convincing people to go 100% stocks even though it's something I do in my own portfolio.

  11. @Gene: I see your point. I'm used to listening to people support their views with some long list of reasons that are all nonsense except for one important one. I tend not to focus on the count of reasons, but rather the balance of importance. So, I didn't notice that I had the optics wrong on this post.

  12. I meant my post to be humourous, so hopefully that shines through more than me being a critical jerk. :-) You actually did the right thing by mentioning the pros and cons.

  13. @Gene: You mean the "pro and cons" :-) I saw the humour in you remark, but you made me think about how my post looked from a simple count of pros (1) and cons (more than 1).

  14. I'm glad to finally find one blog that doesn't tell me I'm crazy for having a 100% stock portfolio. I've been through 3 crashes so far and have not flinched. Although I expect to move my portfolio towards something more conservative when I get within 5 years of retirement, with 20+ years left to work I'm not terribly worried about being in 100% stocks. I'm more worried about not getting the benefit of compound growth rather than the yo-yo gyrations of the stock market.

  15. @Tara C: I don't think you're crazy. But I think you are best off being adequately diversified in your stock selection -- personally, I own index ETFs. I also don't use leverage because it can force me to sell when my stocks are down.