Asset Allocation Explained: Balancing Stocks, Bonds and Cash

Asset allocation is the way you divide your investments among different asset classes, such as stocks, bonds and cash. It is one of the most important decisions an investor makes, because the mix of assets in a portfolio has a major influence on both its potential growth and how much it may rise and fall along the way.

Each asset class behaves differently. Stocks offer the highest long-term growth potential but can be volatile in the short term. Bonds generally provide steadier income and lower volatility, helping cushion a portfolio when stock markets decline. Cash and cash equivalents offer stability and easy access, but their returns may not keep pace with inflation over long periods.

Finding the right mix for you

There is no single ideal allocation. The right mix depends on your goals, your time horizon and your tolerance for risk. A younger investor saving for retirement decades away may hold a larger share of stocks, since there is time to recover from market downturns. Someone nearing retirement may prefer a larger share of bonds and cash to protect savings they will soon need.

Your personal comfort with risk matters too. If large swings in your portfolio would cause you to sell investments in a panic, a more conservative allocation may help you stay invested. The best allocation is one you can stick with through both strong and difficult markets.

Diversification will not eliminate risk, but it helps make sure no single investment can derail your plan.

Diversify and rebalance

Within each asset class, diversification spreads your money across many different investments. For stocks, that may include companies of different sizes, industries and regions. For bonds, it can mean a mix of government and corporate issuers with different maturities. Low-cost index funds and exchange-traded funds can make broad diversification simple and affordable.

Over time, market movements will shift your portfolio away from its target allocation. If stocks perform well, they may grow to represent a larger share than you intended, increasing your risk. Rebalancing, which means periodically selling some of what has grown and buying more of what has lagged, brings your portfolio back in line with your plan.

Review your allocation at least once a year and whenever your goals or circumstances change significantly. Gradually adjusting your mix as you approach major goals helps you protect the progress you have made while still giving your money room to grow.

The advisors at Wealth Advice Guide build diversified portfolios matched to your goals and comfort with risk. Contact us for a free portfolio review.