What is asset allocation and why is it important?
Guide Summary
- Asset allocation is the process of spreading investments across different asset classes to match your goals and risk tolerance.
- A well-planned asset allocation can help manage risk while aiming for steady, long-term growth.
- Your ideal allocation may change over time, so reviewing and adjusting it regularly is important.
What is asset allocation?
Asset allocation is how you divide your investments between different asset types like stocks, bonds, property, and cash — to help achieve your financial goals.
Each asset type behaves differently, and the right mix can help balance growth potential with risk.
Why is asset allocation important?
Asset allocation is important to ensure your investments match your goals and risk tolerance. Rather than randomly picking investments, it’s about choosing the right balance of assets to suit you.
Different assets respond differently to market conditions. For example, when stocks fall, bonds might hold steady or even rise. By blending asset classes, you reduce the impact of any single investment performing badly.
Without asset allocation, your portfolio could end up being too risky (or too cautious) without you realising it. A deliberate mix helps keep you on track towards your goals while managing the bumps along the way.
See our full guide on risk, returns, and investment strategies.
Maximising return whilst minimising risk
Every investor wants good returns, but chasing the highest potential gains often means taking on more risk. Asset allocation helps you find the sweet spot between risk and reward that works for you.
For example:
- Stocks tend to have higher long-term returns but more short-term volatility.
- Bonds generally offer lower, steadier returns and act as a stabiliser during downturns.
- Cash equivalents are the safest, but have minimal growth potential.
By combining these assets in the right proportions for your goals, you can aim for growth while potentially cushioning against big losses. If you need the money in the short term, you might lean towards safer assets; if you’re investing for decades, you could afford to take more risk for potentially higher returns.
See our full guide on investment types and asset classes.
Conservative portfolio vs aggressive portfolio
Two investors can have completely different asset allocations depending on their risk tolerance and objectives. For example:
- Conservative portfolio — Might hold 70% bonds, 20% stocks, 10% cash. Lower volatility, smaller potential gains, more focus on preserving capital.
- Aggressive portfolio — Could be 80% stocks, 15% bonds, 5% cash. Higher volatility, greater potential returns over the long term, more tolerance for short-term dips.
Your portfolio can sit anywhere along this spectrum, and it can evolve as your circumstances change.
See our full guide on defensive and aggressive investing.
What is age-based asset allocation?
Age-based asset allocation is a simple strategy that adjusts your mix of assets as you get older. The idea is to keep a higher risk profile when you’re younger and gradually reduce it as you near your financial goals.
A common rule of thumb suggests subtracting your age from 100 or 120 to find the percentage of your portfolio to invest in stocks.1 For example:
- If you’re 30: 100 − 30 = 70% stocks, with the rest in bonds and cash.
- If you’re 60: 100 − 60 = 40% stocks, with a larger portion in lower-risk assets.
It’s not a one-size-fits-all formula, but it’s a useful starting point for thinking about how risk profiles might change over time.
See our full guide on retirement and long-term investing.
How to rebalance your portfolio
Over time, market movements can shift your asset allocation away from your original target. For example, if stocks perform well, they might make up a larger share of your portfolio than planned, which could mean more risk than you intended.
Rebalancing means selling some of the assets that have grown too much and buying more of the ones that have lagged, to restore your desired allocation. Many investors review and rebalance their portfolios once or twice a year.
Making small, purposeful changes can help to keep you moving towards your goal.
Asset allocation summary
Asset allocation is the foundation of a sound investing strategy, helping you balance risk and reward through the right mix of asset classes. Your allocation should reflect your goals, risk tolerance, and time horizon, and it’s worth adjusting it as your life and the markets change.
Next in this series: The importance of diversification — how spreading your investments further within asset classes can strengthen your portfolio.
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than your original investment. Chip does not offer financial advice and this should not be considered as a personal recommendation.
