Asset Allocation
Asset allocation decides how much to hold in stocks, bonds, cash, commodities and other assets. Learn the main approaches, a 60/40 example and how to choose a mix.
Asset allocation is the decision of how to divide money among broad asset classes: stocks, bonds, cash, real estate, commodities and, for some investors, alternatives such as crypto. For long term investors it is usually the most important portfolio decision, because different asset classes behave very differently over time and in crises. Choosing individual stocks or funds matters less than getting the overall mix right for your goals, time horizon and tolerance for losses.
The main asset classes#
| Asset class | Role | Typical behaviour | Lesson |
|---|---|---|---|
| Stocks | Long term growth | High return, high volatility, large drawdowns | What Is a Stock? |
| Government bonds | Stability, income, crisis protection | Lower return, lower volatility; often rise when stocks fall, but not always | What Is a Bond? |
| Corporate bonds | Higher income | Between stocks and government bonds | Corporate Bonds |
| Cash and bills | Liquidity, safety | Low return, near zero volatility | Treasury Bills, Notes and Bonds |
| Commodities and gold | Inflation protection, diversification | Volatile; sometimes rise when stocks and bonds fall | What Are Commodities? |
| Real estate | Income, inflation link | Can be illiquid; listed real estate behaves partly like stocks | |
| Crypto | Speculative growth, diversification debated | Extremely volatile | Bitcoin |
Approaches to asset allocation#
| Approach | How it works |
|---|---|
| Strategic | A long term target mix, rebalanced periodically. See Rebalancing |
| Tactical | Temporary shifts around the target based on market views. See Macro Trading |
| Age based (glide path) | Shift from stocks to bonds as a target date approaches |
| Risk parity | Balance risk contributions rather than dollar amounts. See Risk Budgeting and Risk Parity |
| Optimised | Mean variance or other optimisation. See Modern Portfolio Theory and the Efficient Frontier |
| All weather style | Balance exposure to growth and inflation regimes |
The classic 60/40 portfolio#
A long standing benchmark is 60% stocks and 40% bonds. It aims to capture much of the stock market's growth while bonds soften the falls.
Choosing your allocation#
| Factor | Effect |
|---|---|
| Time horizon | Longer horizons can tolerate more stocks |
| Risk tolerance | Ability and willingness to endure drawdowns. See Maximum Drawdown |
| Income needs | More bonds and cash for near term spending |
| Other wealth | Job stability, home ownership, pensions |
| Inflation exposure | Real assets can help |
A useful test: imagine your portfolio falling by half the worst historical drawdown of its riskiest asset. If that would make you sell, the allocation is too aggressive.
Asset allocation versus security selection#
A widely cited 1986 study by Brinson, Hood and Beebower found that asset allocation policy explained most of the variation in pension funds' returns over time. The exact interpretation has been debated, but the practical lesson holds: the mix of asset classes drives most of a diversified portfolio's ups and downs. See Diversification.
Traders and allocation#
Active traders also allocate: between trading capital and long term savings, across strategies and across markets. Keeping a core long term allocation separate from a trading account limits the damage a bad trading year can do. See Investing vs Trading and Bankroll Management.
Frequently asked questions#
What is asset allocation?#
Deciding how to divide a portfolio among asset classes such as stocks, bonds, cash, commodities and real estate.
Is 60/40 still a good portfolio?#
It remains a common benchmark, but its performance depends on stock and bond correlations and starting yields; it suffered in 2022 when both fell.
How often should I change my asset allocation?#
Strategic allocations usually change only when goals or circumstances change, with periodic rebalancing back to targets.
Next, learn why combining assets reduces risk in Diversification.
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