Takeaways
- Asset allocation is the process of determining the best mix of assets for your portfolio.
- Investment professionals use asset allocation to balance risk and return.
- High-risk assets are balanced with low-risk assets to achieve your risk profile.
- Recommended asset allocations are based on your age, time horizon, and capital.
- Asset allocations are utilized to achieve both short-term and long-term investment goals.
Whether you're just starting to invest or are approaching retirement, asset allocation plays a pivotal role in shaping your financial future. The goal of asset allocation is to help you balance investment risk and reward, aligning your money with your financial goals.
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What Is Asset Allocation?
Asset allocation is the process of dividing your investment portfolio among various asset classes, including stocks, bonds, real estate, cryptocurrencies, and cash. Each asset class behaves differently in various market conditions. Financial planning utilizes these differences in market behavior to create the right allocation for a smooth glide path for your investments.
Stocks tend to offer higher returns but come with greater volatility and more inherent risk. Bonds provide more stability and income, albeit with lower returns. Cryptocurrencies offer the allure of alternative forms of payment and high appreciation. Cash or cash equivalents are the safest but offer the least growth. By spreading your investments across the different asset classes, you reduce the impact of any single asset's performance on your overall portfolio.
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How Asset Allocation Works
Asset allocation begins with understanding your investment goals. If you are in your 20s or 30s, for example, you might be focused on creating a winning 401(k) plan. With this in mind, you may want to consider building a diversified portfolio. This might look something like investing your 401(k) contributions in:
- 60% stocks
- 30% bonds
- 10% cash
An investment mix like this is designed to generate growth through stocks while mitigating risk with the steadier returns of bonds and the liquidity of cash.
However, this may only be a starting point. Over time, the value of each asset class will fluctuate, potentially causing your target allocation to skew. To stay aligned with your original risk level, you may need to rebalance, shifting funds between asset classes to restore your desired allocation.
Read More: What Is a Stock Market?
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Why Asset Allocation Is Important
Asset allocation is often considered more important than individual stock selection in achieving long-term investment success. Here's why it matters:
- Reduces risk – Investment diversification across asset classes can cushion your portfolio during bull and bear markets. (Read more about investment diversification).
- Improves returns - By optimizing your time horizon and goals, you increase your chances of meeting your long-term money objectives. (Read more about How to Retire Early).
- Builds discipline - Having a strategy in place reduces the urge to react emotionally to market swings. Unlike being a stock trader, long-term investing generally involves a set-it-and-forget-it approach, with regular monitoring and reviews. (Read more about How to Start Investing).
Asset Allocation at Your Age
Your investment age plays a significant role in determining the recommended level of aggressiveness or conservatism in your asset allocation. Here's a general guideline by decade:
- In your 20s, a higher allocation to stocks (up to 90%) is typically recommended since you have time to ride out market fluctuations.
- In your 30s, you may still prioritize growth but with a more balanced approach, such as an 80%/20% or 70%/30% stock-to-bond ratio.
- In your 40s, many investors opt for a 60%/40% split or even a 50%/50% split, depending on your family responsibilities, income stability, and retirement goals.
- In your 50s, with retirement approaching, preserving capital becomes more important. A more conservative mix, consisting of 40% stocks, 50% bonds, and 10% cash, is typical.
- In your 60s, at or near retirement age, income and stability are top priorities. A portfolio with a heavier emphasis on bonds and cash helps minimize volatility—consider an allocation of 30% stocks, 60% bonds, and 10% cash.
>> Are all stocks equal? Learn more about Why a Stock’s Beta Matters
Asset Allocation Funds
Asset allocation funds do the work for you, providing a convenient and stress-free way to invest. These are mutual funds or ETFs that hold a mix of asset classes within a single investment. Examples include:
- Balanced funds – These funds typically maintain a fixed ratio of stocks and bonds (e.g., 60%/40%).
- Target-risk funds - Designed around a specific risk profile, like conservative, moderate, or aggressive.
How Target Date Funds Work
Target-date funds are a type of asset allocation fund that adjusts your investment mix based on your expected retirement year (the "target date"). In a recent Vanguard study, approximately 64% of all plan contributions were directed to target-date funds.[1]
For example, a 2055 target-date fund begins with a significant allocation to stocks. As the target year approaches, the portfolio gradually becomes more conservative, shifting from stocks to more conservative investments, such as money market accounts and bonds. This gradual shift begins to discharge risk as you approach retirement without requiring manual rebalancing.
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Best Asset Allocation Strategy
There's no one-size-fits-all strategy, but your optimal allocation should reflect:
- Financial Goals: Are you saving for retirement, a home, or college tuition? Your investment time horizon and objective will influence your asset mix.
- Risk Tolerance: How comfortable are you with market ups and downs? If you panic at the thought of losing money, a conservative allocation may be a better fit for you. Knowing your risk tolerance is critical to setting an anxiety-free investment plan.
- Investment Age: Your age, or more accurately, your time until you need your money, plays a significant role in determining your ideal allocation. For example, you might want to invest in a CD to earn interest for a couple of years while you save for a down payment on a home.
- Retirement Plans: If you have a pension or other guaranteed income in retirement, you may be able to afford a more aggressive allocation. Most investment portfolios tilt to fixed-income plans when you approach retirement.
Rules of Thumb for Asset Allocation
There are awesome personal finance rules of thumb that can guide your asset allocation strategy. One popular rule is the "100 minus your age" guideline.
This investment allocation approach suggests subtracting your age from 100 to get your recommended percentage of stocks. The remainder is allocated to bonds and cash. For example, here's how it would work if you're 30:
- 100 – 30 = 70% stocks, 30% bonds and cash
Read Also: What Is a Bond Ladder?
Smart Summary
By diversifying your investments across stocks, bonds, certificates of deposit, and high-interest savings accounts tailored to your goals and risk tolerance, you can reduce volatility and increase your chances of success over time. Whether you adopt a DIY approach to portfolio management or opt to allocate everything to target-date funds, investment professionals emphasize the importance of staying diversified, revisiting your allocation periodically, and allowing your investment plan to evolve in line with your lifestyle.
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(1) Vanguard. How America Saves 2024. Last Accessed June 8, 2025.
