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Concept

Asset Allocation

Asset allocation is the decision about how your money is split between broad categories such as stocks, bonds and cash, and it shapes how much your portfolio rises and falls far more than the choice of any single fund.

Picking a good index fund answers what to own inside stocks. Asset allocation answers a bigger question: how much of your money sits in stocks at all, and how much in bonds? Research on diversified portfolios suggests this split explains much of the ups and downs you will actually live through. Two things should set it. The first is time horizon. Burton Malkiel shows in A Random Walk Down Wall Street that a broad stock index can lose a third in one year. Over twenty years, though, the range of average yearly outcomes has historically been far narrower and mostly positive. Money you need in three years belongs mostly in bonds or cash. Money for thirty years away can carry more stocks. The second is behaviour. The best mix is one you will not abandon in a bad year. After that, you rebalance on a calendar, not a mood.

A real-life example

Dana, 31, is a nurse in Leeds. She keeps her retirement savings at 80% in a global stock index and 20% in bonds. The house deposit she needs in two years sits in a savings account. In a year when stocks drop 25%, her mix drifts to roughly 75/25. Every April she moves it back to 80/20. That means buying stocks while they are cheap, without predicting anything.

How to use it

  1. 1Sort your money by when you need it. Anything due within about five years goes mostly into bonds or cash. Long-term money can lean on stocks.
  2. 2Choose a simple split for the long-term part, such as 70/30 or 60/40, and test it honestly: if stocks fell by a third tomorrow, would you hold?
  3. 3Pick one fixed date each year to rebalance back to your target, and leave the split alone the rest of the year.