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Background: I'm a young 20-something, I won't be retiring for 40+ years, and the expense ratios for the funds offered in my company's 401(k) plan mostly suck. The company matches 35% of my contributions up to a limit. The plan doesn't offer a large cap fund.

I understand that one of the reasons an all-stock portfolio isn't recommended is because of the volatility, though stocks will provide some of the best long-term returns. Considering my scenario, what drawbacks would I have were I to solely invest in stock-based funds? (going by expense ratios, my only viable choices are Vanguard mid-cap at 0.24% and Vanguard small-cap at 0.30%)

This question appears to be related: If low-cost index funds are considered the best investment, why are there so many high-cost, managed funds?

JohnFx
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Bigbio2002
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3 Answers3

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At your age, I don't think its a bad idea to invest entirely in stocks. The concern with stocks is their volatility, and at 40+ years from retirement, volatility does not concern you. Just remember that if you ever want to call upon your 401(k) for anything other than retirement, such as a down payment on a home (which is a qualified distribution that is not subject to early distribution penalties), then you should reconsider your retirement allocations. I would not invest 100% into stocks if I knew I were going to buy a house in five years and needed that money for a down payment.

If your truly saving strictly for a retirement that could occur forty years in the future, first good for you, and second, put it all in an index fund. An S&P index has a ridiculously low expense ratio, and with so many years away from retirement, it gives you an immense amount of flexibility to choose what to do with those funds as your retirement date approaches closer every year.

Jesse
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  • Looks like this answer has been blessed with the JoeTaxpayer Seal of Approval(TM) :). Given my choices listed above, should I split my funds between the two (if so, why is there a benefit?), or should the general strategy be to invest 100% into the fund with the lowest expense ratio? – Bigbio2002 Mar 28 '13 at 15:12
  • Without knowing which funds are available, I would say to split it. Also, I would try to find an international fund. – Kevin Mar 28 '13 at 16:19
  • @Kevin, I listed the fund choices in the question. – Bigbio2002 Mar 28 '13 at 19:45
  • In my opinion, an S&P 500 index fund is built-in diversification. Your investment is being spread across 500 individual companies. Your investing in the market as a whole. With 40 years on your side, you can monitor the general direction of the market and decide what other options to take as your retirement gets closer. If you really want to look at other funds, consider Precious Metals or International Stocks; maybe 10% of your total portfolio should go to these "ultra high risk" funds. – Jesse Mar 28 '13 at 20:37
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    @Bigbio2002 I meant if I knew your full list of choices I might advise you to go with some of the other ones. Knowing only very limited information on those two, I'd split between the two of them. – Kevin Mar 28 '13 at 21:15
  • @Kevin, gotcha. All of the other funds have 1%+ expense ratios, which I don't want compounding on me. The S&P 500 fund they offer is 0.7%, which is quite high. – Bigbio2002 Mar 28 '13 at 22:50
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    I would not ever plan on using a 401k for a house down payment. I do agree with the part of this answer about being find for all stocks, but I don't think a 401k loan is even a remotely good idea. YMMV. – enderland Mar 29 '13 at 13:08
  • @Bigbio2002, .7 is really not that high. I currently have my 401K split evenly between 4 funds. A large cap growth with an expense ratio of .91, a mid cap blend at .14, a small cap growth at 1.25(high, but has a really good track record), and an international at .85. The main thing, though, is to take advantage of the match that your company provides, otherwise you are giving away money. – Kevin Mar 29 '13 at 14:59
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    @Kevin I guess I'm spoiled by my employer and my experience with Vanguard, because 0.7% seems really high. Apart from an international equity fund with an ER of 0.45%, all of my 401K options are below 0.17% (most are below 0.05%). Your small cap growth fund may have good performance, but 1.25% will eat away a lot of that. – John Bensin Jun 05 '13 at 20:30
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    @Kevin: Anything above .1% is high IMO. The biggest Vanguard mutual funds have expense ratios of .04%. Most 401k options are horribly overpriced. – Brian Feb 13 '18 at 22:37
  • So I went back and checked the four funds I spread my investments over. .05%, .06%, .50% and .52%. The highest expense ratio one has the best performance over all time frames (1, 3, 5, and 10 years). Significantly so over the past year, moderately so over the longer periods. However, when you factor in the 15% discount and great performance, none of them come close to touching the employee stock purchase from my company. – Kevin Feb 14 '18 at 15:23
  • Some would argue that stock in your own company is sorta the antithesis of diversified. Not only is it a single stock, it means if your company goes through hard times both your job and your savings are at risk. ESPPs can be wonderful (or not), but they should still be only part of your portfolio, like any other single stock . – keshlam Dec 20 '23 at 15:25
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The advantage of being young is not that you can take the "safest" path from the beginning instead of catching it up mid-life, the real advantage is that you have plenty of time to recover from your errors.

The investment goes the same way.

Your investment has a lot of time, so it has a lot of time to recover from the swings of the stock-market.

You can take the "risky" all stocks fund.

EarlGrey
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I've read a nice rule of thumb somewhere that you should consider:

You should invest (100-YOURAGE)% of your money in stock

The rest should be something less volatile and more liquid, so you have some money when the stock market goes down and you need some money nevertheless.

So you would start with buying about 75% stock and balance your stock percentage over time by buing more secure assets to keep the stock percentage at the desired level. At some time you might need to sell stock to rebalance and invest in more secure assets.

Note: That's a general rule of investment and doesn't consider 401(k) laws like restrictions on getting the money before retirement. In case the 401(k) money is locked up, you can put the 401(k) money in stocks and have the non-stocks part of your strategy outside of 401(k) at the beginning. As you age you would most likely need to rebalance your 401(k) money to include non-stock as well to achieve the lower stock ratio suggested for higher age.

Jan Bühler
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    This is silly advice for someone early in their career. Over 40 years the stock market will beat bonds handsomely. The bond part of the portfolio is just a useless drag since he is so far from retirement. – zeta-band Nov 08 '17 at 18:15
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    Someone early in their career will end up with ~75% stock. This rule of thumb takes into account that one might very well need some extra money before retiring - e.g. buying a house or emergency situations that need accessible money. Also it helps to stay on track with the investing plan - if you got all stocks and the stocks go badly for the first 5 years one might get very nervous when you have 100% stocks. It is however a rule of thumb and only a starting point for a custom strategy. – Jan Bühler Nov 28 '17 at 10:01
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    If you are going to need money for a house, you shouldn't be investing it in your 401K at all. And you most definitely shouldn't be using your 401K as your emergency fund. – Kevin Feb 14 '18 at 15:26
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    I'm german so I don't have any clue about 401k. I've included a note to reflect that and outline how that should be taken in consideration. In case you know more about 401k and can enhance the answer go for it - thanks for your comment. – Jan Bühler Feb 15 '18 at 12:05
  • @zeta-band, did you misread the formula ? – Fattie Feb 15 '18 at 12:48
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    @Fattie Nope. That formula is a common one and not hideously bad for someone in mid life, but for a young person it is needlessly conservative. – zeta-band Feb 15 '18 at 16:26
  • I disagree on the "needlessly conservative" judgement. Assuming two people aged 25 start with 100% stock and 75% stock and in five years the stock market goes down. The person having 25% (or, by then 30%) will be much more likely to stick with the strategy than the person thats 100% stock. In case you're absolutely sure that you won't act like that (many do and loose money in the process), you can individually adjust your formula, using the rule of thumb as a starting point. Also, starting with some non-stock will lead to buying extra stock in a low stockmarket when rebalancing. – Jan Bühler Feb 20 '18 at 13:32