—how you divide money between different types of investments—is the most important investment decision you'll make.
Why It Matters
Studies show that asset allocation determines about 90% of your portfolio's returns over time. Not stock picking. Not market timing. Just the mix.
| Asset Class | Risk Level | Historical Return | Best For |
|---|---|---|---|
| Stocks | High | 7-10%/year | Long-term growth |
| Bonds | Low-Medium | 3-5%/year | Stability, income |
| Cash | Very Low | 0-2%/year | Short-term needs |
| Real Estate | Medium | 4-8%/year |
The Risk-Return Tradeoff
Pro Tip
Higher potential returns = higher potential losses. There's no free lunch in investing.
100% Stocks:
- Best year: +37%
- Worst year: -37%
- Long-term average: ~10%
60% Stocks / 40% Bonds:
- Best year: +28%
- Worst year: -22%
- Long-term average: ~8%
The second portfolio made less but with WAY less stomach-churning volatility.
Allocation By Age (Rules of Thumb)
The "Age in Bonds" Rule
Your age = percentage in bonds
- Age 25: 25% bonds, 75% stocks
- Age 45: 45% bonds, 55% stocks
- Age 65: 65% bonds, 35% stocks
The "110 Minus Age" Rule (More Aggressive)
110 - your age = percentage in stocks
- Age 25: 85% stocks
- Age 45: 65% stocks
- Age 65: 45% stocks
Watch Out
These are starting points, not gospel. Your personal situation—job stability, other income, risk tolerance—matters more than formulas.
Building Your Allocation
Step 1: Determine Your Time Horizon
| Time Until You Need Money | Stock Allocation |
|---|---|
| 20+ years | 80-100% |
| 10-20 years | 60-80% |
| 5-10 years | 40-60% |
| Under 5 years | 0-40% |
Step 2: Assess Your Risk Tolerance
Honest questions:
- If your portfolio dropped 30%, would you panic sell?
- Do market fluctuations keep you up at night?
- Can you afford to lose some money short-term?
If you can't stomach volatility, reduce stock allocation.
Step 3: Keep It Simple
A three-fund portfolio works for most people:
- US Stocks: 50-60%
- International Stocks: 20-30%
- Bonds: 10-30%
Rebalancing
Over time, your allocation drifts as different assets grow at different rates.
Example:
- Start: 70% stocks, 30% bonds
- After a good stock year: 80% stocks, 20% bonds
Do This
Rebalance once or twice a year back to your target. This forces you to "sell high, buy low" automatically.
Quick Win
Check your 401k or allocation right now. Does it match your target? Most plans have automatic rebalancing options—turn it on.