And should you? Most people in the financial independence community recommend using VTSAX (Vanguard’s Total Stock Market Index Fund) to save for retirement. It’s a fantastic idea in general, and it’s what I recommend to most people for most of their money. 

100% Stocks

If you are young and you still have a lot of years of investing, having your savings 100% in stocks could make sense. Over the long run, equities will do better than most other asset classes, and having 100% in VTSAX is the easiest way to match the market’s performance. The only potential pitfall is that the stock market can be volatile. If you haven’t been at this for a while, you might not remember the dot com bubble in the early 2000s or the housing crash in 2008.

If you kept your money in the market, you’ve been fine. Better than fine, great really. The last 10 years have been a fantastic time to be invested in the market, and you would have made it all back and then some. That is, assuming you held the course and stayed in the market. But can you handle that 50% drop? Can you stomach seeing your net worth get cut in half?

Psychology

If you can, great. But if not, what are the options? None of this works if you get cold feet and pull your money out of the market when it goes down 30%. As with a lot of things, investing and personal finance are about psychology as much as they are about math. You need to know yourself, and you should make decisions based on that, and not just the math sometimes. JL Collins has a great post about this psychology in his fantastic stock series.

So, do you have the stomach for a 50% drop in your net worth in a short amount of time? Honestly, I hope so, because that is the best way to become wealthy in the long term. Put it all in VTSAX and hold on for the ride. Over time the market goes up, and you will eventually become very wealthy.

That being said, this isn’t the path for everyone. If you take this advice but then panic at the bottom and sell because you can’t take it anymore it will be devastating for your portfolio. So how can you smooth the ride?

Bonds

The way to smooth the ride is generally with bonds. The most often mentioned index is VBTLX, (Vanguard’s Total Bond Market Index Fund). There is a lot to learn about bonds, (and you can by clicking this link), but the general idea is that they are much less volatile and much safer than stocks, especially when we are talking about a large index such as VBTLX. Because of this, they have a lower return than stocks. That’s ok though because their job is to smooth the ride.

Depending on your risk tolerance and time until retirement, it may make sense to add 10, 20, or perhaps an even bigger percentage of bonds to your portfolio. Even if you have a long time until retirement it’s possible you just don’t have the stomach for the stock market and prefer the relative safety of bonds. In these cases, it’s not a bad idea to allow for some bond allocation. It will smooth the ride and hopefully keep you from selling in panic.

Rebalancing

One of the biggest ways bonds help, in my opinion, is through rebalancing your portfolio. In general, the idea is that if you decide you want 70% stocks and 30% bonds, over time you’ll have to rebalance your portfolio to keep it that way. If stocks go up, you’ll end up with 75% stocks and 25% bonds. If stocks go down, you’ll end up with 65% stocks, and 35% bonds. When they get out of balance, you sell the one that has gone up and buy the one that has gone down.

This is basically magic for your portfolio. It literally forces you to sell high and buy low. That is significantly better than what most people do, which is buy high and sell low because of greed and fear. You don’t even have to do it that often. Quarterly or even yearly is fine.

Conclusion

Should you have 100% in VTSAX? Maybe. If you are young, I expect that will work out just fine for you. Personally, I have most, but not all of my investments in it. I’m slightly more cautious than some, and as much as I don’t think anyone should try to time the market, I can’t help but think after 10 years the bull run might run out of steam at some point. If 10-20% bonds help you sleep better at night I definitely think that is fine, and it could end up being better than 100% stocks. If we do get the pullback, you’ll end up with more shares of VTSAX. If we don’t, it won’t significantly hinder your performance.

If you like to be in control and DIY your investments, check out our Vanguard review. It’s not that hard to buy VTSAX and VBTLX and then rebalance occasionally. If you’d rather not have to think about it, check out our Betterment review. With Betterment, you can just set an allocation strategy (i.e. 80% stocks and 20% bonds), and they will rebalance for you automatically. Just set it and forget it. Whatever you decide, just stick with it and invest as much as you can. If you save 50% of your income, that will easily cover up any mistakes you might make with your asset allocation. If the market goes down, just think of all the extra shares of VTSAX you’ll be getting with your high savings rate. In all likelihood, it will go back up before you hit retirement.