Asset Allocation
Strategic distribution of investments across different asset classes
Category: Investment Strategy
Difficulty: Beginner
Definition
How you split your money between different types of investments like stocks, bonds, and cash.
Why This Matters
Studies show that how you divide your money between asset types matters more than which specific investments you pick. It’s responsible for about 80-90% of your returns.
Basic Types of Investments
Stocks (Equities) - Pieces of companies - Higher growth potential but more ups and downs - Good for long-term goals
Bonds (Fixed Income) - Loans to companies or governments - Steadier returns, less risky than stocks - Provide regular income
Cash and Cash Equivalents - Savings accounts, money market funds, CDs - Very safe but low returns - Good for emergency funds
Simple Asset Allocation Rules
Age-Based Rule - Put your age in bonds, rest in stocks - Example: Age 30 = 30% bonds, 70% stocks - Gets more conservative as you age
Target Date Approach - Use target date funds that adjust automatically - Starts aggressive when young, gets conservative near retirement - Simple solution for most people
Three-Fund Portfolio - Total stock market index - International stock index
- Bond index - Covers everything with low costs
Common Allocation Examples
Aggressive (Young Investors) - 80% stocks, 20% bonds - Higher risk, higher potential return
Moderate (Middle-aged) - 60% stocks, 40% bonds - Balanced approach
Conservative (Near Retirement) - 40% stocks, 60% bonds - Lower risk, steadier income
When to Rebalance
Time-Based - Review once or twice per year - Sell what’s done well, buy what’s lagged behind
Threshold-Based - Rebalance when allocations drift 5-10% from target - Example: 60% stock target becomes 70%, time to rebalance
Common Mistakes
- Trying to time the market with your allocation
- Making dramatic changes based on news
- Forgetting about taxes in taxable accounts
- Over-complicating with too many asset classes
Bottom Line
Keep it simple. Pick an age-appropriate mix of stocks and bonds, use low-cost funds, and rebalance occasionally. Don’t overthink it.
Further Reading
Classic Research: - Portfolio Selection - Harry Markowitz (1952), Nobel Prize-winning paper - Determinants of Portfolio Performance - Brinson, Hood & Beebower (1986)
Practical Guides: - Asset Allocation Principles - Bogleheads Wiki, free resource - Three-Fund Portfolio - Simple implementation guide