While there are many investment options, they all fall into a few categories. The three main types of investments are stocks, bonds, and cash equivalents. Everything else, including real estate, gold, and cryptocurrency, is considered an alternative investment.
Most investors have a mix of stocks, bonds, and cash, plus maybe some alternative investments. But the stock market has historically provided a fantastic combination of growth potential and reliability, so some people opt to invest all their money in stocks. It's especially popular with younger investors who have decades until retirement.
Is this a good idea, or is it too risky? To help you figure out if this option is right for you, let's look at what you can expect with a stock-only portfolio and the potential pitfalls.
Your portfolio will likely perform very well over the long haul
A stock-only portfolio is a great way to maximize growth. Over long periods of time, the stock market has delivered excellent returns for investors. The S&P 500, an index of 500 of the largest publicly traded U.S. companies, is a perfect example. It has an average return of about 10% per year, before inflation.
Nothing else has done so well for so long. The potential returns with stocks are far higher than what's possible with bonds or cash.
It's worth mentioning that past performance is no guarantee of future results. Just because the stock market has returned an average of 10% per year doesn't mean it will continue to do so. Still, it has historically been an extremely effective way to build wealth. If that continues, then putting all your money in stocks will pay off in ways that a more balanced portfolio won't.
Some years will be much better than others
Although the stock market has done well over long periods of time, its year-to-year performance is highly volatile. Don't expect a steady 10% per year, because returns are anything but predictable. As far as performance goes, here's a more accurate idea of what it's like:
- Some years deliver fantastic returns. For example, the S&P 500 rose 34.1% in 1995, 29.6% in 2013, and 28.9% in 2019.
- There's the occasional year with big losses. This hasn't happened too much in the 21st century, but the S&P 500 declined by 23.4% in 2002, 38.5% in 2008, and 19.4% in 2022.
- Many years are in between those two extremes. Occasionally, gains or losses are very low or practically flat.
Fortunately for investors, the good years far outnumber the bad years. However, you need to be prepared for that volatility when you invest in stocks, especially if you put all your money in them.
You could be short on cash when you need it
This is only going to be a problem if you invest absolutely all your money in stocks. If that's your plan and you don't keep any cash on hand, you're going to run into problems with any big bills that come up.
For example, let's say your car breaks down and you need $3,000 to get it fixed. If you have all your money invested, you may be forced to sell some of your stocks. If they've gone down in value, that will mean selling at a loss.
You can put your entire investment portfolio in stocks if you want. The key is not to put literally all your money in stocks. Outside of your investment portfolio, you should have an emergency fund with enough to cover at least three months of expenses, as well as savings for any short-term goals and large future expenses you need to plan for.
You'll need to make changes when you're close to retirement
A stock-only portfolio works when retirement is still a long way off. If you're not planning to retire for another 20 or 30 years, you have enough time to ride out the year-to-year ups and downs.
As you get closer to retirement, wealth preservation starts to take precedence over wealth building. You can still keep the bulk of your portfolio in stocks, but it also becomes important to diversify.
Once you're about 10 to 15 years from retirement, start adding bonds to your portfolio for more stability. Those who are retired or getting close to retirement often go with a 70:30 or 60:40 stocks-to-bonds ratio. The right ratio for you will depend on your risk tolerance.
Even if it sounds extreme, a 100% stock portfolio can be a great choice for investors who don't mind the volatility and have plenty of time until retirement. Just make sure you have a diversified stock portfolio with a large number of companies. You can do that yourself or by investing in index funds, such as an S&P 500 or total stock market fund.
