The Basic Principles of Asset Allocation
"Don't put all your eggs in one basket." Asset allocation implements this proverb with math. Let's look at how diversification raises return relative to risk.
What Is Asset Allocation?
Asset allocation is a strategy of dividing your total investment across several asset classes.
Major asset classes: - Stocks (domestic/overseas): high long-term return, high volatility - Bonds (government/corporate): low return, low volatility, low correlation with stocks - Cash and short-term bonds: safe but weak against inflation - Real estate (including REITs): an inflation hedge, dividend income - Commodities (gold, oil, etc.): an inflation hedge, independent movement
The heart of asset allocation is combining assets that move differently to lower the overall portfolio's volatility.
Age-Based Asset Allocation Rules
A traditionally cited rule: "stock weight = 100 - age"
Age 20: 80% stocks, 20% bonds Age 40: 60% stocks, 40% bonds Age 60: 40% stocks, 60% bonds
The rationale for this rule: the younger you are, the more time you have to recover losses, and the older you are, the more important preserving principal becomes.
In modern times, as life expectancy has risen, some revise it to "110 - age" or "120 - age." This rule is for reference only and should vary according to your risk tolerance, income, and goals.
This content is for educational purposes. For your personal asset allocation, consult a professional.
The Math of Asset Allocation: Correlation
The effect of asset allocation is explained by correlation.
Correlation +1: two assets move in exactly the same direction -> no diversification effect Correlation 0: two assets move independently -> reduced volatility Correlation -1: two assets move in exactly opposite directions -> a perfect hedge
Historically, the correlation between U.S. stocks and U.S. long-term bonds was low or negative (bond prices rise when stocks fall). This is why the stock+bond combination became the basis of the traditional portfolio. However, in periods of surging rates like 2022, stocks and bonds can fall together.
常见问题
Q. What asset allocation suits a beginner investor?
A commonly cited starting point is a global stock index fund (60-80%) plus a bond index fund (20-40%). But the "right allocation" varies greatly with your investment purpose, horizon, and risk tolerance. We recommend using this service to directly simulate the historical performance of various asset allocations.
Q. Once I set an asset allocation, is it permanent?
No. When your life stage, financial situation, or goals change, your asset allocation should be adjusted too. Generally, as you age, or as your withdrawal date nears, you adjust toward reducing the weight of risky assets. You should also maintain your target weights through regular rebalancing.
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