Investopedia/James Chen: What Is Asset Allocation?

Investopedia                                                                       Investing Mutual Funds
Asset Allocation
Reviewed by James Chen
Updated May 5, 2019
What is Asset Allocation

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon. The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.
2:07
Strategic Asset Allocation to Rebalance Portfolios
Why Asset Allocation is Important

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, the selection of individual securities is secondary to the way that assets are allocated in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

Investors may use different asset allocations for different objectives. Someone who is saving for a new car in the next year, for example, might invest her car savings fund in a very conservative mix of cash, certificates of deposit (CDs) and short-term bonds. Another individual saving for retirement that may be decades away typically invests the majority of his individual retirement account (IRA) in stocks, since he has a lot of time to ride out the market's short-term fluctuations. Risk tolerance plays a key factor as well. Someone not comfortable investing in stocks may put her money in a more conservative allocation despite a long time horizon.
Age-based Asset Allocation

In general, stocks are recommended for holding periods of five years or longer. Cash and money market accounts are appropriate for objectives less than a year away. Bonds fall somewhere in between. In the past, financial advisors have recommended subtracting an investor's age from 100 to determine how much should be invested in stocks. For example, a 40-year old would be 60% invested in stocks. Variations of the rule recommend subtracting age from 110 or 120 given that the average life expectancy continues to grow. As individuals approach retirement age, portfolios should generally move to a more conservative asset allocation so as to help protect assets that have already been accumulated.
Achieving Asset Allocation Through Life-cycle Funds

Asset-allocation mutual funds, also known as life-cycle, or target-date, funds, are an attempt to provide investors with portfolio structures that address an investor's age, risk appetite and investment objectives with an appropriate apportionment of asset classes. However, critics of this approach point out that arriving at a standardized solution for allocating portfolio assets is problematic because individual investors require individual solutions.

The Vanguard Target Retirement 2030 Fund would be an example of a target-date fund. As of 2018, the fund has a 12-year time horizon until the shareholder expects to reach retirement. As of January 31, 2018, the fund has an allocation of 71% stocks and 29% bonds. Up until 2030, the fund will gradually shift to a more conservative 50/50 mix, reflecting the individual's need for more capital preservation and less risk. In following years, the fund moves to 67% bonds and 33% stocks.
Compete Risk Free with $100,000 in Virtual Cash
Put your trading skills to the test with our FREE Stock Simulator. Compete with thousands of Investopedia traders and trade your way to the top! Submit trades in a virtual environment before you start risking your own money. Practice trading strategies so that when you're ready to enter the real market, you've had the practice you need. Try our Stock Simulator today >>
Compare Popular Online Brokers
Related Terms
Multi-Asset Class
Multi-asset class investing reduces risk by spreading money across stocks, bonds or other assets.
more
Asset Allocation Fund
An asset allocation fund is a fund that provides investors with a diversified portfolio of investments across various asset classes.
more
Target-Date Fund
A target-date fund is a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal.
more
Tactical Asset Allocation (TAA)
Tactical Asset Allocation (TAA) is an active management portfolio strategy which re-balances holdings to take advantage of market prices and strengths.
more
Asset Mix
Asset mix is the breakdown of all assets within a fund or portfolio.
more
Asset Class Breakdown
An asset class breakdown provides the percentages of core asset classes found within a mutual fund, exchange-traded fund or other portfolio.
more
Related Articles

Bonds / Fixed Income
Asset Allocation In A Bond Portfolio

Investing Strategy
Is Warren Buffett's 90/10 Asset Allocation Sound?

Investing Strategy
Six Asset Allocation Strategies That Work

Mutual Funds
Target-Date Funds: Advantages and Disadvantages

High Net Worth Strategy
How to Achieve Optimal Asset Allocation

Investing Strategy
5 Things to Know About Asset Allocation

    About Us
    Advertise
    Contact
    Privacy Policy
    Terms of Use
    Careers

Investopedia is part of the Dotdash publishing family.

    The Balance
    Lifewire
    TripSavvy
    The Spruce
    and more