Looking at the long-term performance of the S&P 500, you might wonder why you wouldn’t just invest your entire 401(k) in it. The numbers are compelling: the index has averaged around 10.5% per year historically, and its returns in recent years have been even stronger.
So why not just go all in?
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The answer depends on where you are in your financial journey, whether you are still in the accumulation phase and heading towards retirement, or whether you are already in retirement and relying on investments for income. In either case, 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, or 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 the compound do its thing in the decades leading up to retirement.
Regular 401(k) contributions also provide a built-in benefit in the form of dollar cost averaging. By contributing a portion of each paycheck, you automatically buy more shares when prices are low and less when prices are high. Over time, dollar cost averaging helps mitigate volatility and takes the emotion out of the decision-making process. It’s a disciplined, consistent approach that rewards and reinforces patience.
But there’s a difference between being cautiously aggressive and going all red. Investing 100% of your 401(k) in the S&P 500 comes with some significant risks that aren’t always obvious at first glance. (And if you need help selecting investments that align with your goals, talk to a financial advisor.)
For most young investors, the first and most important question is not whether you can bear the risk; it’s whether you can stay the course when volatility occurs.
Market history offers some humbling reminders. The S&P 500 has experienced several periods of severe decline and years of flat or negative returns. These times are known as the “lost decades”. In the 2000s, for example, investors who remained fully invested in the index saw no real growth for 10 years. The same was true in parts of the 1970s and, on a more extreme scale, during the Great Depression.
Even during an investor’s lifetime, sudden market declines of more than 30% are inevitable. When those times come, the headlines are bleak, jobs can be at risk and economic data can deteriorate. If your 401(k) balance is suddenly cut in half, will you stay invested and stay focused for the long haul?
Many investors believe they will. Until they experience it. Our own firm’s experience has shown that risk tolerance questionnaires tend to look much more aggressive in bull markets than in bear markets. (Consider working with a financial advisor if you need help avoiding making emotional financial decisions.)
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On its surface, the S&P 500 appears broadly diversified. After all, it owns 500 companies across all major industries. But recent trends, investment themes and investor preferences have caused the index to become much more concentrated than its name suggests.
Specifically, 10 stocks account for more than 30% of the index’s total weight and have generated roughly the same proportion of total returns over the past few years. When these companies (which are mostly in the technology and communications services sectors) perform well, the index returns look fantastic. But when they stumble, the entire index suffers.
Another layer of focus comes from geographic exposure. The US currently accounts for about half of the world’s total investment market, an unusually high percentage compared to history. By investing exclusively in the S&P 500, you’re effectively betting that US companies will continue to outperform every other region indefinitely. Including exposure to international equities and other asset classes can reduce risk and improve long-term results without abandoning an equity-oriented approach.
(And if you need help spreading your portfolio across different asset classes and regions, consider working with a financial advisor.)
If the argument is whether you should invest in an asset that can generate 10.5% annually, why not invest in something that has performed even better? Over the past decade, Nvidia has delivered incredible returns: over 50% per year on average. So why not put all your money into Nvidia?
Because that story cuts both ways. Between 2001 and 2002, Nvidia’s stock fell 90%. Even in the last 15 years, there have been four separate pullbacks of more than 30%. Would you have stayed invested in every prolonged recession?
While the S&P 500 is obviously more diversified than a single company, the behavioral challenge is similar. From 2000 to 2002, the index fell about 47%, then lost 50% just a few years later during the global financial crisis of 2008. Even diversified markets can test your beliefs.
Diversification is not about eliminating risk, but about managing it. By owning other asset classes, such as bonds, international stocks or real assets, you consciously trade some 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 come back?” but “What if the market goes down when I need to make withdrawals?”
This is known as return succession risk and can have lasting consequences.
Imagine a retiree with a $2 million portfolio invested entirely in the S&P 500, who plans to withdraw $500,000 toward a home purchase. If the market goes down 50%, that portfolio drops to $1 million. Now, that same $500,000 withdrawal is half of the portfolio, not a quarter. To return to its original value, the remaining $500,000 would have to quadruple. It could take decades to fully recover in a period of life where time is not necessarily on your side.
That’s why liquidity and diversification matter so much in retirement. By having access to lower-volatility assets for short-term needs, the rest of the portfolio can recover and continue to accumulate. (Consider working with a financial advisor as you approach and enter retirement.)
The psychological challenges of investing don’t go away in retirement. If anything, they intensify. Without a regular salary, your portfolio becomes your only source of income. During downturns like the COVID-19 selloff, many retirees felt immense pressure to switch to cash because markets were near rock bottom. Those emotional decisions can have long-term costs that are hard to recover from.
At the same time, staying too conservative can create its own problem: longevity risk, or the risk of outliving your money. Given that retirement can last 20 or 30 years, you still need growth to maintain purchasing power and keep up with inflation.
The solution is not a binary choice between “all actions” or “no actions”. It’s about matching your investments to your time horizon. For example, funds you will need in the next 12-24 months can be set aside in low-volatility assets such as cash or short-term bonds, while long-term funds remain invested for growth. (If you’re looking for a customized retirement investment plan that aligns with your timeline and comfort level, contact a financial advisor for free.)
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Whether you’re just starting to build wealth or preparing to live off it, investing is always a balance between growth and protection. The S&P 500 has proven to be a powerful engine for the long-term combination, but even the best engine needs a stabilizer.
A well-diversified portfolio does not mean sacrificing returns. It means making the ride easier so you can stay invested in all types of market environments. By incorporating a mix of asset classes, aligning your risk with your time horizon, goals, assets and liabilities, and recognizing the emotional side of investing, you give yourself the best chance to capture the long-term benefits of the market without letting short-term volatility derail your plan.
Ultimately, investing isn’t about finding the “perfect” allocation; it’s about finding the one you can stay with.
Many plans allow you to automate ongoing portfolio maintenance, which can reduce drift and keep your target allocation intact during volatile markets. If your plan offers a managed account option, it may offer a more personalized allocation than a standard target date fund, although it’s worth comparing any added fees with the service offered.
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 retirement sequencing. Finding a financial advisor doesn’t have to be difficult. The free SmartAsset tool matches you with verified financial advisors serving your area, and you can have a free introductory call with your matched advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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 about 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 dbroot.com.Please note that Jeremy is not a SmartAsset AMP participant and is not an employee of SmartAsset.
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