Portfolio Allocation
Portfolio allocation is how your money is divided between assets or strategies, such as 60% shares and 40% bonds.
How much you put into each kind of asset often matters more than which individual assets you pick. Portfolio allocation is that decision: the split between shares, bonds, cash and other assets — or, for traders, between strategies and markets. It sets the overall risk and return of the portfolio and decides how hard the bad years hit. This entry explains how allocation works, how to choose one, and how to keep it on target.
- Category
- Accounting, Tax and Operations
- Reading time
- 4 min
- Also called
- Asset allocation, Allocation, Strategic allocation
- Updated
Portfolio allocation in plain words
Asset allocation means dividing your investments among different categories, such as stocks, bonds and cash.1 A portfolio of 80% shares is riskier than one of 40% shares, whatever shares you choose.
The right mix depends on your time horizon, how much risk you can tolerate and your goals.2 See Diversification.
How to set an allocation, step by step
Define the goal and horizon
Money needed in two years needs a different mix from money needed in twenty.
Decide how much decline you can live with
A larger share of volatile assets means deeper drawdowns. See Drawdown.
Choose the asset classes
Shares, bonds, cash, commodities — or strategies and markets for traders.
Set target weights
For example 60% shares, 30% bonds, 10% cash.
Spread within each class
Avoid concentration in one company or theme.3
Rebalance on a schedule
Bring weights back to target. See Rebalancing.
Worked examples
Example 1 — Allocation drives the swings
Bad yearShares fall 30% and bonds rise 3% in a bad year.
| 80/20 portfolio | 0.8 × −30% + 0.2 × 3% ≈ −23.4% |
| 40/60 portfolio | 0.4 × −30% + 0.6 × 3% ≈ −10.2% |
The split between asset classes decides most of the damage.
Example 2 — Drift without rebalancing
DriftA 60/40 portfolio sees shares rise 40% while bonds stay flat.
| New weights | ≈ 68% shares / 32% bonds |
Strong markets quietly raise your risk. Rebalancing restores the intended mix.
Example 3 — Allocating between strategies
StrategiesA trader splits capital 50/50 between a trend-following and a mean-reversion system.
| Effect | Smoother combined results when the systems behave differently |
Allocation applies to strategies too. See Trend Following and Mean Reversion.
Common allocation approaches
| Aspect | Idea | Trade-off |
|---|---|---|
| Fixed (strategic) | Set weights, rebalance regularly | Simple; ignores conditions |
| Age- or goal-based | Less risk as the goal approaches | Depends on the goal’s timing |
| Tactical | Shift weights with market views | Needs skill; can add risk |
| Risk-based | Weight by volatility or risk | More complex. See Risk Parity, Minimum Variance and the Efficient Frontier |
Why allocation matters
Setting overall risk
The mix decides how far the portfolio can fall.
Behaviour
A mix you can live with is a mix you can stick with.
Diversification
Spreading across asset classes reduces dependence on one market. See Correlation.
Traders’ capital
Splitting capital across strategies and markets.
Advantages and disadvantages
Advantages
- Controls overall risk more than individual picks.
- Simple to understand and to maintain.
- Reduces dependence on any single market.
Disadvantages
- No allocation removes market-wide risk.
- Correlations between assets can change.
- Drift requires regular rebalancing.
- Too cautious a mix can miss long-term growth.
Going deeper
Read as far as you need. Each level builds on the one before it.
Cash is an asset class too
Beginner
Holding some cash lowers volatility and gives flexibility, at the cost of lower long-term returns.
Rebalancing rules
Intermediate
Common rules are calendar-based (for example yearly) or threshold-based (when a weight drifts more than a set amount). Both bring risk back to plan.
Allocation by risk, not money
Advanced
A 50/50 split by money between shares and bonds is not 50/50 by risk, because shares are usually far more volatile. Risk-based methods size each part by its volatility. See Volatility.
Common mistakes
Choosing a mix you cannot hold through a crash
Test it against a bad year.
Never rebalancing
Drift changes your risk.
Over-diversifying into similar assets
Check correlations.
Changing the plan after every move
Allocation is a long-term decision.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Allocation is how money is split between asset classes or strategies.
- It sets most of the portfolio’s risk.
- Choose it from goals, horizon and risk tolerance.
- Diversify within each class too.
- Rebalance to keep the intended mix.
Frequently asked questions
What is the best asset allocation?
How often should I rebalance?
Does allocation matter for active traders?
Further learning
- Diversification
Why spreading money reduces risk.
- Correlation
How assets move relative to each other.
- Drawdown
How allocation shapes the worst declines.
- Volatility
Why risk differs between asset classes.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Investor.gov (SEC). Asset Allocation (glossary) (opens in a new tab) Checked .
- StockCharts ChartSchool. Asset Allocation and Diversification (opens in a new tab) Checked .
- Investor.gov (SEC). Diversification (glossary) (opens in a new tab) Checked .
Read more elsewhere
- Trading Metrics (our sister site): Asset Allocation (opens in a new tab)
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. Trading Metrics is our sister site, under the same ownership; we are not affiliated with any other publisher linked above. Last reviewed . Report an error or request a source credit.