New Here! Need Advice and Clarification on 100% Equities

[FIRE-Man]

Hi All,

I've been lurking on the Forum for some time now and have a question regarding one of the recurring themes I've seen on the boards. Basically I keep hearing the statement that 100% equities will get "crushed" over time. I understand there is inherent risk involved, but if I own an equity index like VTSAX, how is it possible the money I invest will ever go to zero ? Wouldn't the stock market have to fall to zero in it's entirety, and in any case I would still own the worthless shares if it were to come back ? This is probably a very stupid question but I can't seem to work out the answer in my head. I appreciate any insight/input you may have.

Also, I would appreciate an azimuth check from the other members here. I am 29, my wife 35. As of this year we are all maxing out 401k's, IRA's and outside of that saving about 24K a year, which amounts to about a 55 percent savings rate for us. The only task we've yet to master is the investment of that other "24k" which is just sitting around doing nothing. I plan to never work another day past 40 as I will have a military retirement and can draw from the TSP at 54, so basically I only need enough cash to last 14 years, which amounts to about 750k, if I don't manage to pay the house off in that time-frame.  Any advice you can provide would be a huge help. Thank you all so much and I seriously love this community of folks.

[Argyle]

My guess about the 100% equities thing is that if the stock market tanks, and all your stocks are worth a tiny amount for a while — let's say four years — for four years you could be having to withdraw money to live at a rate that loses you a lot of money (compared to your initial investment), while you wait for the value to rebound.  If you have investments in other sectors, you're safe from having to withdraw money from your stocks while they're down.  You can draw from your bonds, your CDs, your rental income, or whatever, while you're waiting out the dip.

[FIRE-Man]

Ahh, ok. So the statement about equities getting crushed is in the retirement phase then, when you would need to draw from this pool of money and not in what I am considering the purely "savings and growth" phase of that money? If that's correct then it makes much more sense. Hopefully others have some experience to share as well. Thank you !

[sol]

Yes, the crushing refers to making inflation adjusted withdrawals on a depleted account during a downturn.  Flexible spending removes much of that risk.

Your 24k of cash can go into a taxable brokerage account someplace like vanguard, where you can invest it in any kind of index or mutual fund you like.  If you like 100% equities then vtsax or vt are good low cost options. 

You'll get taxed on distributions from funds in the taxable brokerage account if you're above the 15% tax bracket, so better to invest in things where most of the growth is in capital appreciation instead of dividends.

[FIRE-Man]

Sol/Argyle,

Thank you all for the responses. They have been very helpful. If one wanted to diversify more, say outside of 100 percent equities, are there index funds that incorporate both securities and equities ? Am I mixed up and basically describing a mutual fund ? The main purpose of my question would be diversification while limiting fees.

[sol]

Sure, there are diversified vanguard funds that are essentially an entire portfolio in one.  I would probably opt for one of the target date funds like vtthx, but keep in mind that the bond allocation will throw off interest that you may be taxed on in a taxable account.

The general rule of thumb is that if you want to hold income generating assets like bonds, it's better to hold them inside of one of your tax sheltered accounts, and leave your taxable account full of equities or tax free municipal bonds.  So for example, you might hold vtsax in your brokerage account but change your TSP allocation by making new contributions to something more conservative like L2030.  That would give you the same diversification in a more tax efficient manner.

[FIRE-Man]

Is sheltering the bonds because you don't want to be taxed on an allocation with a typically lower yield ? I also, appreciate the clarification on the TSP because I tend to think of money invested in different places as needing to be diversified in and of itself, as opposed to all our investments as one large portfolio.

[sol]

Is sheltering the bonds because you don't want to be taxed on an allocation with a typically lower yield ?

No, a bigger yield, paid out in taxable form.

A stock index fund probably throws of about 2% dividend, as that's the dividend yield on the S&P500.  If you're above the 15% tax bracket you'll pay taxes on that yield because it is considered income.  But most of the value in the fund is expected to come from price appreciation as the market climbs, which is not taxed until you sell, if ever.

If you instead buy a bond fund, you would normally expect a much higher yield but little to no price appreciation.  All of that added value from the investment would get taxed this year.

If you're going to get taxed on interest income but not capital appreciation, put your appreciating assets in a taxable account and your income generating assets in a tax sheltered account (like the TSP).