Detailed Explanation
Asset allocation is the strategic decision of how to divide your investment portfolio among different asset categories. Some research suggests it may have a significant impact on long-term portfolio outcomes.
Major Asset Classes
Equities (Stocks): Higher growth potential (8-12% historical average returns) with higher volatility. Often used for long-term goals.
Fixed Income (Bonds): Lower returns (4-6%) but more stability. Provides income and cushions stock volatility.
Cash and Equivalents: Lowest returns but immediate access. Emergency funds and short-term needs.
Real Estate: Income and appreciation potential. Direct property, REITs, or real estate funds.
Age-Based Allocation Guidelines
Rule of 110: A commonly referenced guideline that subtracts age from 110 for stock percentage. Example: Age 30 = 80% stocks, Age 50 = 60% stocks. This is a simplified heuristic, not a personalized recommendation.
Target-Date Funds: Automatically adjust allocation as you age. Designed for simplicity, though may not suit everyone’s situation.
Rebalancing
Over time, market movements shift your allocation. Rebalancing returns it to target:
- Calendar: Some investors rebalance annually or quarterly
- Threshold: Some rebalance when allocation drifts 5%+ from target
- Concept: Involves selling assets that have grown and buying those that have declined
Examples
Allocation by Age/Risk Tolerance
| Profile | Stocks | Bonds | Cash |
|---|---|---|---|
| Aggressive (20s-30s) | 90% | 10% | 0% |
| Growth (30s-40s) | 80% | 15% | 5% |
| Moderate (40s-50s) | 60% | 35% | 5% |
| Conservative (50s-60s) | 40% | 50% | 10% |
| Retirement Income | 30% | 55% | 15% |
Simple Three-Fund Portfolio
- Total US Stock Market: 60%
- Total International Stock: 20%
- Total Bond Market: 20%
Why It Matters
Asset allocation is a core concept in portfolio management:
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Portfolio Outcomes: Some studies suggest asset allocation may explain a significant portion of portfolio return variability over time.
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Risk Considerations: Allocation choices affect exposure to market volatility.
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Comfort Level: Some investors consider whether they can tolerate potential losses when choosing an allocation.
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Time Horizon: Near-term goals are often associated with more conservative allocations; longer time horizons may allow for more volatility.
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Framework: Having a defined allocation can provide structure for investment decisions.
This is general educational information. Individual circumstances vary, and a financial advisor can help determine an appropriate approach.