Asset Allocation
How you divide a portfolio among stocks, bonds, cash, and other asset types — the single biggest driver of its risk and return.
What Asset Allocation means
Asset allocation is the mix of broad asset classes in your portfolio. It is a strategic decision made before you pick any individual fund, and research has repeatedly found it explains most of the variation in a portfolio's returns over time.
The classic tradeoff is stocks versus bonds. Stocks carry higher expected returns and much larger swings; bonds are steadier and cushion downturns. A portfolio that is 90% stocks will grow faster over decades but can lose a third of its value in a bad year.
The right allocation depends mainly on your time horizon and your genuine tolerance for loss. Money you need in three years does not belong in stocks; money you will not touch for thirty probably should not sit in cash.
Allocation drifts as markets move, which is why it is paired with periodic rebalancing.
Related terms
Diversification
Spreading money across many investments so that a loss in any one of them does limited damage to the whole portfolio.
Rebalancing
Periodically buying and selling to return a portfolio to its target mix after market moves have shifted it.
Bond
A loan you make to a government or company that pays you regular interest and returns your principal on a set maturity date.
Index Fund
A fund that mechanically tracks a market index rather than picking stocks, giving broad exposure at very low cost.
ETF (Exchange-Traded Fund)
A fund holding a basket of investments that trades on an exchange like a single stock, usually tracking an index at low cost.
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