Glossary · Investing and personal finance
Asset allocation
Asset allocation is how you split your money between kinds of investments, such as stocks, bonds and cash. It decides most of how a portfolio behaves.
Also called: investment mix, stock/bond split, portfolio allocation
A year. Worst year: −39.3% (2008).
Worst year: −27.7% (1917).
Worst year: −20.2% (2022).
In plain words
Think of a pizza you are sharing out between toppings: so much for pepperoni, so much for mushrooms. Asset allocation is the same choice for money: what share goes into stocks, what share into bonds, what share stays in cash, and perhaps some in gold or property.
The split matters more than almost any other investing decision. Stocks have grown the most over long periods but can lose half their value; bonds and cash grow more slowly and fall less. More stocks means a higher expected return and a bumpier ride; more bonds, the reverse.
The split is often written stocks/bonds: 60/40 means 60% stocks and 40% bonds. Since 1871, a 60/40 mix of US stocks and 10-year Treasuries, reset every January, returned 5.6% a year after inflation, against 7.1% for all stocks and 2.4% for all bonds.
Example
How the split changes a bad year
Take $100,000 and a year in which stocks fall 30% and bonds gain 5%.
- 100% stocks: $100,000 → $70,000 (−30%).
- 60/40: $60,000 × 0.70 + $40,000 × 1.05 = $42,000 + $42,000 = $84,000 (−16%).
- 30/70: $30,000 × 0.70 + $70,000 × 1.05 = $21,000 + $73,500 = $94,500 (−5.5%).
In a good year the order flips: the more stocks, the bigger the gain. The split sets the size of the swings in both directions.
One level deeper
A famous 1986 study of US pension funds by Brinson, Hood and Beebower found that their asset mix explained over 90% of how their returns moved up and down from quarter to quarter; picking stocks and timing explained little. It is often misquoted as “90% of returns”, but the point stands: the split drives the ride.
People usually choose a split by time and temperament: how soon the money is needed, and how big a fall they could sit through without selling. A common rule of thumb holds “110 minus your age” percent in stocks; target-date retirement funds shift from stocks to bonds automatically as their date nears.
Over time the mix drifts as some assets grow faster than others; putting it back to the target is rebalancing. Bonds are not risk-free either: after inflation, the deepest fall of an all-bond portfolio, between 1941 and 1981, was −58%, worse than the −48% of the 60/40 mix at its worst.
Six stock–bond mixes since 1871: the return a year after inflation
US stocks and 10-year Treasury bonds in six proportions, each reset to its target every January. Over this long stretch more stocks meant more growth, and deeper falls on the way: the worst year after inflation was −39.3% for all stocks against −27.7% for 60/40.
The numbers behind the chart
| Value | |
|---|---|
| 100% stocks | 7.1% |
| 80% stocks / 20% bonds | 6.4% |
| 60% stocks / 40% bonds | 5.6% |
| 40% stocks / 60% bonds | 4.6% |
| 20% stocks / 80% bonds | 3.6% |
| 100% bonds | 2.4% |
Why it matters
It decides most of your long-run return and most of your worst year, far more than which fund or stock you pick.
It is the knob you control. Markets you cannot control; how much of your money is exposed to them, you can.
A mix you can live with is one you can stick with. The worst results usually come from abandoning a plan in the middle of a crash.
A common mistake
Myth: Bonds are the safe part, so they cannot lose much.
In fact: In dollars they swing far less than stocks, but inflation can eat them. After inflation, 10-year Treasuries returned −20.2% in 2022. Between 1941 and 1981, inflation took their value down by 58% from its high.
Questions people ask
What is a good asset allocation?
There is no single right mix: it depends on when the money is needed and how big a fall its owner can live with. As a reference point, the classic balanced fund holds about 60% stocks and 40% bonds. Since 1871, that mix returned 5.6% a year after inflation, with a worst year of −27.7%.
Does asset allocation change with age?
Many people hold fewer stocks as they get closer to needing the money, because there is less time to recover from a fall. Target-date funds do this automatically, moving from mostly stocks to mostly bonds over the decades before their date.
What are the main asset classes?
Stocks (owning companies), bonds (lending to governments and companies), cash (bank deposits and Treasury bills), real estate, and commodities such as gold. Each has a different mix of growth, income and risk.
Read more on BigCapital
About the numbers
- The numbers on this page are recalculated from the data every night; the sources are listed at the end of the page.
- US 10-year Treasury bonds, total return index: Robert J. Shiller, Online Data (shillerdata.com), ie_data.xls, sheet "Data": "Long Interest Rate GS10", checked against "Monthly Total Bond Returns" and "Real Total Bond Returns".
- S&P Composite price and total return since 1871, and US consumer prices: Robert J. Shiller, Online Data (shillerdata.com); total return with dividends reinvested monthly, calculated by BigCapital.
- This page explains a term. It is not investment advice.