> ## Documentation Index
> Fetch the complete documentation index at: https://docs.chicago.global/llms.txt
> Use this file to discover all available pages before exploring further.

# Asset Allocation

> Understanding asset allocation - dividing your portfolio among asset classes

Asset allocation is how you divide your portfolio among different asset classes: stocks, bonds, cash, real estate, and alternatives. Research shows it's the most important investment decision you'll make.

## Beginner

### What It Means

Asset allocation is your portfolio's recipe - how much of each ingredient (asset class) to include. It determines your risk level and expected return more than any other decision.

### Common Allocations

| Profile      | Stocks | Bonds | Cash | Risk Level    |
| ------------ | ------ | ----- | ---- | ------------- |
| Aggressive   | 90%    | 10%   | 0%   | High          |
| Growth       | 80%    | 20%   | 0%   | Moderate-High |
| Balanced     | 60%    | 40%   | 0%   | Moderate      |
| Conservative | 40%    | 50%   | 10%  | Low-Moderate  |
| Preservation | 20%    | 60%   | 20%  | Low           |

### The 60/40 Portfolio

The classic "balanced" portfolio: 60% stocks, 40% bonds. It's a common starting point that balances growth potential with stability.

### Why It Matters

Research shows asset allocation explains about 90% of portfolio return variability over time. Individual stock selection matters far less than your mix of stocks vs. bonds vs. other assets.

***

## Advanced

### The 90% Rule

**Brinson, Hood, and Beebower (1986)** found that asset allocation explains over 90% of the variation in portfolio returns over time. This landmark study shifted focus from stock picking to strategic allocation.

<Note>
  This doesn't mean 90% of returns come from allocation - it means 90% of return *differences* between portfolios are explained by allocation differences.
</Note>

### Strategic vs. Tactical

| Approach      | Description                 | Typical Changes    |
| ------------- | --------------------------- | ------------------ |
| **Strategic** | Long-term target allocation | Rarely changed     |
| **Tactical**  | Short-term adjustments      | Quarterly or more  |
| **Dynamic**   | Rules-based adjustments     | Automatic triggers |

### Asset Class Characteristics

| Asset Class      | Expected Return | Volatility   | Role                    |
| ---------------- | --------------- | ------------ | ----------------------- |
| **Equities**     | Highest         | Highest      | Growth                  |
| **Bonds**        | Moderate        | Low-Moderate | Income, Stability       |
| **Cash**         | Lowest          | Lowest       | Liquidity, Safety       |
| **Real Estate**  | Moderate-High   | Moderate     | Diversification, Income |
| **Commodities**  | Variable        | High         | Inflation hedge         |
| **Alternatives** | Variable        | Variable     | Diversification         |

### Historical Returns

Long-term annualized returns (US, approximate):

| Asset Class          | Return | Volatility |
| -------------------- | ------ | ---------- |
| US Stocks            | 10%    | 16%        |
| International Stocks | 8%     | 18%        |
| US Bonds             | 5%     | 4%         |
| Cash/T-Bills         | 3%     | 1%         |
| REITs                | 9%     | 18%        |

### Allocation by Age

Traditional rule of thumb: "100 minus your age" in stocks.

| Age | Stocks | Bonds |
| --- | ------ | ----- |
| 25  | 75%    | 25%   |
| 40  | 60%    | 40%   |
| 55  | 45%    | 55%   |
| 70  | 30%    | 70%   |

<Warning>
  This is a rough guideline only. Individual circumstances (risk tolerance, other assets, income needs) matter more than age alone.
</Warning>

### Modern Portfolio Theory

**Harry Markowitz (1952)** showed how to optimize allocation for maximum return at each risk level - the "efficient frontier."

Key insight: Combining assets with low correlation reduces portfolio risk below the weighted average of individual risks.

### Factors Affecting Allocation

| Factor                   | Impact on Stocks % |
| ------------------------ | ------------------ |
| Longer time horizon      | Higher             |
| Higher risk tolerance    | Higher             |
| Stable income            | Higher             |
| Large emergency fund     | Higher             |
| Near-term spending needs | Lower              |

### Rebalancing

Asset allocation drifts as markets move. Rebalancing returns the portfolio to target:

* After stocks rise: Sell stocks, buy bonds
* After stocks fall: Sell bonds, buy stocks

This enforces "buy low, sell high" discipline.

### Data and Implementation

| Consideration       | Details                                    |
| ------------------- | ------------------------------------------ |
| Review Frequency    | Annually at minimum                        |
| Rebalancing Trigger | 5% drift from target typical               |
| Tax Efficiency      | Rebalance in tax-advantaged accounts first |
| Costs               | Consider transaction costs vs. precision   |

### Related Terms

<CardGroup cols={3}>
  <Card title="Diversification" href="/glossary/diversification">
    Core principle of allocation
  </Card>

  <Card title="Portfolio Rebalancing" href="/glossary/portfolio-rebalancing">
    Maintaining target allocation
  </Card>

  <Card title="Correlation" href="/glossary/correlation">
    Key to allocation benefits
  </Card>
</CardGroup>