Hey!
My wife and I each contribute the max to our employer sponsored plans (457 and 403b for her, 401 for me). We each have a balance of roughly 100k that is completely invested in VTSAX (her) and SP500 index (me).
We do not have any investments outside of this.
My question is, at what point should we consider diversification beyond what we have now and why?
Thank you!
When your progress toward your financial goals makes it rational to do so, taking into account your risk tolerance.For example, let's suppose your risk tolerance is high, by which I mean, even if both indexes you're invested drop another 30% in the next month, it won't bother you too much. Which is a very rational attitude for a gainfully employed couple making substantial retirement contributions already. In this example, let's further suppose that your goal is Financial Independence, that the amount of money you need to reach FI is $1 million ignoring any possible pension, and the current $200k balance (or $185k, based on the last couple of days' drops) represents the fact that most of your accumulation phase is still ahead of you.
Based on a high risk tolerance and the fact you're not close to FI, 100% stock is a reasonable allocation. There will presumably be big swings up and down between now and FI, but the odds of them changing the outcome dramatically are low enough that many people (including me, who has a much more diversified portfolio) feel it's reasonable in your case.
Later, for example when you reach 700k out of your $1 million example, it becomes more important to diversify. Opinions differ as to whether and why you should, but a common scenario would be to focus on a 70% stock 30% bond portfolio during FI, to provide more stability during downturns (thanks to the bond component) while retaining most of the growth potential (thanks to the stock portion plus the chance to rebalance on a steady, perhaps annual basis, which historically has proven effective). After reaching the 700k mark, you could choose to invest primarily in bonds, unless stock drops during the final years cause you to need some stock investing to reach the desired 70/30 ratio.
Another pattern for tapering from 100% stock to a stock/bond diversification would be to start your taper 5 years before your estimated FI date. Each year, you could target a fifth of the transition. So if you were investing $100k/year and at $400k portfolio you anticipate you're 5 years from FI after accounting for estimated gains, in that year you might establish a year end target of being 6% in bonds (one fifth of 30%). The following year, you'd increase to 12% bonds. To save on taxes, you could adjust your contributions each year to seek the desired year-end allocation; that way, you wouldn't need to sell anything unless stock valuations rise faster than your contribution rate.
Those are examples of your investment context determining the proper allocation. That, not market timing, should drive your allocation decisions. When stocks are dropping rapidly like the past couple days, I would not sell stock or change from a 100% stock allocation.