Looking at the long-term performance of the S&P 500, you might wonder why you wouldn’t invest your entire 401(k) in it. The numbers are compelling: The index has historically averaged about 10.5% per year, and has returned even higher in recent years.
So why not go “all in”?
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The answer depends on where you are in your financial journey, whether you’re still in the accumulation phase and preparing for retirement, or you’re already retired and relying on your investments for income. In both cases, there are real advantages to owning the S&P 500. But there are also significant risks and blind spots that deserve attention.
For investors in their 20s, 30s, and even 40s, investing heavily in the S&P 500 makes intuitive sense. Time is on your side, giving you the ability to weather market cycles and let compound interest work in the decades leading up to retirement.
Making regular contributions to your 401(k) also offers built-in advantages in the form of dollar-cost averaging. By contributing a portion of each paycheck, you automatically purchase more shares when prices are lower and fewer shares when prices are higher. Over time, dollar-cost averaging helps smooth out volatility and remove emotion from the decision-making process. It’s a disciplined, consistent approach that rewards and reinforces patience.
But there’s a difference between a well-thought-out offense and an all-out effort. Investing 100% of your 401(k) in the S&P 500 comes with some meaningful risks that aren’t always obvious at first glance. (If you need help choosing investments that fit your goals, talk to a financial advisor.)
For most young investors, the first and most important question is not whether the risk can be taken, but whether the risk can be taken. The key is your ability to stay the course when volatility occurs.
Market history provides some humbling reminders. The S&P 500 has gone through periods of severe declines and years of flat or negative returns. These periods are known as the “lost decades.” For example, in the 2000s, investors who were fully invested in the index didn’t see any real growth for 10 years. The same was true for parts of the 1970s, and even more extreme during the Great Depression.
Even within an investor’s lifetime, significant market declines of more than 30% are inevitable. When these moments come, the headlines will be grim, jobs may be at risk, and economic data may worsen. If your 401(k) balance were suddenly cut in half, would you continue to invest and focus on the long term?
Many investors believe they will. Until they experience it. Our firm’s experience shows that risk tolerance questionnaires tend to appear more aggressive in bull markets than in bear markets. (If you need help avoiding emotional financial decisions, consider working with a financial advisor.)
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On the surface, the S&P 500 appears to be broadly diversified. After all, it has 500 companies covering all major industries. But recent trends, investment themes and investor preferences have caused the index to become more concentrated than its name suggests.
Specifically, 10 stocks account for more than 30% of the index’s overall weighting and have driven roughly the same proportion of total returns over the past few years. When these companies (mostly concentrated in the technology and communications services industries) perform well, the index’s returns look very good. But when they fall, the entire index suffers.
Another layer of concentration comes from geography. The United States currently accounts for approximately half of the total global investable market, which is an unusually high proportion compared with history. By investing solely in the S&P 500, you are effectively betting that U.S. companies will continue to outperform everything else indefinitely. Investing in international stocks and other asset classes can both reduce risk and improve long-term results without abandoning an equity-oriented approach.
(If you need help expanding your portfolio into different asset classes and geographies, consider working with a financial advisor.)
If the debate is whether you should invest in an asset that may generate 10.5% per year, why not invest in an asset that performs better? Over the past decade, Nvidia has generated incredible returns: an average of over 50% per year. So why not put all your money into Nvidia?
Because this story goes both ways. Between 2001 and 2002, Nvidia’s stock price fell 90%. Even in the past 15 years, it has seen four retracements of over 30%. Will you stay invested during every prolonged economic downturn?
While the S&P 500 is clearly more diverse than a single company, the behavioral challenges are similar. From 2000 to 2002, the index fell about 47%, and a few years later, during the 2008 global financial crisis, it fell 50%. Even a diverse market can test your faith.
Diversification is not about eliminating risk, it is about managing it. By holding other asset classes such as bonds, international stocks, or real assets, you can consciously leverage some of the upside for greater stability when volatility strikes, especially when you least expect it.
As you approach retirement, the conversation changes. The question is not just “What will the market return?” but “What if the market goes down when I need to withdraw my money?”
This is called a reward-risk sequence, and it can have lasting consequences.
Imagine a retiree has a $2 million portfolio invested entirely in the S&P 500 Index and plans to withdraw $500,000 to purchase a home. If the market falls 50%, the portfolio will drop to $1 million. Now, that same $500,000 withdrawal represents half of the portfolio, not a quarter. To return to its original value, the remaining $500,000 would need to quadruple. There is a time in your life when time is not necessarily on your side and it can take decades for you to fully recover.
This is why mobility and diversification are so important in retirement. Obtaining less volatile assets to meet near-term needs allows the rest of the portfolio to recover and continue compounding. (As you approach retirement, consider working with a financial advisor.)
The psychological challenges of investing don’t go away after retirement. If anything, they’re more intense. Without a regular salary, your investment portfolio becomes your only source of income. During economic downturns like the COVID-19-induced sell-off, many retirees feel intense pressure to turn to cash as the market approaches lows. These emotional decisions can have long-term costs that are difficult to recover.
At the same time, being too conservative can bring its own problems: longevity risk, or the risk of running out of money. Since retirement may last 20 or 30 years, you still need economic growth to maintain purchasing power and keep pace with inflation.
The solution is not a binary choice between “all stocks” or “no stocks.” It’s about matching your investments to your time horizon. For example, funds you need over the next 12-24 months can be put into less volatile assets like cash or short-term bonds, while longer-term funds continue to be invested in growth. (If you’re looking for a personalized retirement investment plan that fits your timeline and comfort level, contact a financial advisor for free.)
Whether you’re just starting to build wealth or ready to make a living from it, investing is always a balance between growth and protection. The S&P 500 has proven to be a powerful engine of long-term compounding, but even the best engines need stabilizers.
A well-diversified portfolio doesn’t mean sacrificing returns. This means a smooth journey so that you can stay invested in all types of market environments. By integrating multiple asset classes, aligning risk with time horizons, goals, assets and liabilities, and recognizing the emotional component of investing, you’ll get the best chance of reaping the market’s long-term gains without letting short-term fluctuations derail your plans.
In the end, investing is not about finding the “perfect” allocation; It’s about finding someone you can stick with.
Many plans allow you to automate ongoing portfolio maintenance, which can reduce drift and keep your target allocation intact in volatile markets. If your plan offers a managed account option, it may offer more personalized allocation work than a standard target-date fund, although it’s worth comparing any additional fees with the service provided.
A financial advisor can help you integrate your 401(k) strategy with other parts of your financial life, such as taxable investments, Social Security planning and withdrawal sequencing. Finding a financial advisor isn’t difficult. SmartAsset’s free tool matches you with vetted financial advisors serving your area, and you can have a free introductory call with your advisor to decide which one you think is the best fit for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started today.
Have a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Jeremy Suschak, CFP®, is a SmartAsset financial planning columnist who answers readers’ questions on personal finance topics. Jeremy is a Financial Advisor and Head of Business Development at DBR & Co. He was compensated for this article. Additional resources from the author can be found at: Database root directory.Please note that Jeremy is not a SmartAsset AMP participant, nor is he an employee of SmartAsset.
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