Portfolio Allocation Strategies

Portfolio allocation determines how to divide your money among different investments. It's the most important decision affecting your long-term returns. [DEFINITION] Asset Allocation: The process of dividing investments among different asset categories (stocks, bonds, cash) based on goals, risk tolerance, and time horizon. ### Why Allocation Matters [KEY] Studies show asset allocation explains over 90% of portfolio return variation over time—more than individual stock selection or market timing. **The decision order:** 1. How much in stocks vs. bonds vs. cash? (Most important) 2. Within stocks, which sectors/styles? 3. Which specific securities? ### Classic Allocation Rules **Age-Based Rule:** Bond allocation = Your age - Age 30: 30% bonds, 70% stocks - Age 60: 60% bonds, 40% stocks **Modern Adjustment:** Bond allocation = Your age - 20 (for longer lifespans) - Age 30: 10% bonds, 90% stocks - Age 60: 40% bonds, 60% stocks [TIP] These are starting points, not rules. Adjust based on your specific risk tolerance, income stability, and goals. ### Common Allocation Models **Aggressive (100% stocks):** - Long time horizon (20+ years) - High risk tolerance - Stable income - Maximum growth potential **Growth (80/20 stocks/bonds):** - Long time horizon (15+ years) - Moderate-high risk tolerance - Focus on growth with slight buffer **Balanced (60/40 stocks/bonds):** - Medium time horizon (10-20 years) - Moderate risk tolerance - Classic institutional allocation **Conservative (40/60 stocks/bonds):** - Shorter horizon (5-10 years) - Low risk tolerance - Capital preservation focus [EXAMPLE] A 60/40 portfolio: - 60% S&P 500 index (stocks) - 40% Total Bond Market index (bonds) Historically returned ~7-8% with lower volatility than pure stocks. ### Within-Asset Allocation **Stock allocation by style:** - 60% Large-cap - 25% Mid-cap - 15% Small-cap **Stock allocation by region:** - 70% US - 20% Developed International - 10% Emerging Markets **Bond allocation by type:** - 70% Government/Investment Grade - 20% Corporate - 10% International ### Target-Date Funds **Automatic allocation based on retirement year:** - Fund gradually shifts from stocks to bonds - "Glide path" becomes more conservative - One-fund solution for many investors [EXAMPLE] Target 2050 fund today: 90% stocks, 10% bonds Target 2050 fund in 2045: 60% stocks, 40% bonds [WARNING] Target-date funds vary significantly by provider. Some are more aggressive than others. Read the prospectus. ### Rebalancing Your Allocation **When to rebalance:** - On a schedule (quarterly, annually) - When allocation drifts 5%+ from target - After major life changes **How to rebalance:** - Sell winners, buy losers to restore target - Direct new contributions to underweight assets - In retirement accounts (tax-free) is easiest [EXERCISE] You're 35 with a moderate risk tolerance. Design a simple portfolio allocation with percentages for: US stocks, International stocks, and Bonds. Explain your reasoning. |ANSWER| Example: 55% US stocks, 25% International stocks, 20% Bonds. Reasoning: At 35, time horizon is 30+ years, justifying 80% stocks. International provides diversification. 20% bonds adds stability for rebalancing during crashes. This is growth-oriented but not extreme. [SCENARIO] You're 55, planning to retire at 65. Your allocation is 80% stocks, 20% bonds—appropriate when you were 35 but never changed. What should you do? Gradually shift toward a more conservative allocation (perhaps 60/40 or 50/50). This isn't market timing—it's matching your allocation to your life stage. With 10 years until retirement, you have less time to recover from a major crash. However, don't panic-sell to get there. Create a plan to shift over the next few years, perhaps moving 5-10% per year toward bonds.