Building a portfolio
Asset allocation
How you divide money between asset classes — the decision that drives most of your long-run experience.
How it works
Allocation is the split between equities, bonds, cash and anything else. It is set deliberately, in advance, and it is the lever with the largest effect on both return and volatility.
Study after study has found that the allocation explains far more of the variability in a portfolio’s returns over time than the choice of individual securities within each class. Which shares you pick matters; how much you hold in shares at all matters more.
Where it misleads people
An allocation you cannot hold through a crash is not your allocation. The right split is the most aggressive one you will actually keep when it is down 35%, which is usually less aggressive than people assume in calm markets.
Worked example
A 60/40 portfolio holds 60% equities and 40% bonds. A 90/10 portfolio will earn more over decades and will also fall much harder in a bad year, and the person holding it has to be able to live with that.
Related terms
- DiversificationSpreading money across things that do not move together, so no single failure can decide your outcome.
- RebalancingSelling what has grown and buying what has lagged, to return the portfolio to its target mix.
- DriftHow far your actual weights have moved away from the weights you intended to hold.
- Risk toleranceHow much decline you can live through without changing your plan.
- Glide pathA plan to shift gradually from higher-risk to lower-risk assets as a target date approaches.
Mentioned in
More in Building a portfolio
- Concentration risk
- Tactical asset allocation
- Correlation
- Sequence-of-returns risk
- Covariance
- Safe withdrawal rate
- Effective number of holdings
- Efficient frontier
All 20 Building a portfolio terms · The full glossary, 433 terms
Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.