Asset Allocation
Asset allocation is how an investor divides a portfolio among major asset classes such as stocks, bonds and cash, based on goals, time horizon and risk tolerance.
Research on diversified portfolios has found that the mix of asset classes explains much of the variation in a portfolio's returns over time, often more than individual security selection. Stocks offer higher long-term growth potential with larger swings; bonds generally provide income and more stability; cash offers safety and liquidity but low returns.
A classic example is the 60/40 portfolio: 60% stocks and 40% bonds. Younger investors with long horizons often hold more stocks, while those near retirement often shift toward bonds. Target-date funds automate this shift.
Strategic asset allocation sets long-term target weights and sticks to them. Tactical asset allocation makes temporary adjustments based on market views. Over time, market moves push a portfolio away from its targets, which is why investors periodically rebalance.
Example: an investor with $100,000 and a 70/30 allocation would hold $70,000 in stock funds and $30,000 in bond funds. There is no single correct allocation; it depends on personal circumstances.