Asset allocation.
In plain English
Asset allocation is the balance between risky assets (stocks) and steadier assets (bonds and cash) in your portfolio. A 25-year-old saving for retirement might hold 90% stocks and 10% bonds. A 65-year-old already retired might hold 50/50 or even more conservative. There's no perfect mix, there's just the mix that fits your time horizon and how much volatility you can sleep through.
01Why it matters
Studies consistently find that asset allocation explains the majority of long-term portfolio outcomes, far more than which specific stock or fund you pick. Two investors with the same monthly contribution can end up at very different places after 30 years based mostly on how aggressive their allocation was.
02The math, step by step
Two people invest $500/month for 30 years. Person A is in 90% stocks / 10% bonds the whole time and earns roughly 7.5% real return. Person B is in 30% stocks / 70% bonds and earns roughly 4% real return. After 30 years: A has about $660,000. B has about $345,000. Different allocation, different outcome. Person B's portfolio was much steadier along the way; the trade-off was lower long-run growth.
Illustrative example. The amounts here are hypothetical, chosen to show how the math works, not real quoted rates or figures.
03What this is NOT
Diversification is owning many things within a category (many stocks, many bonds). Asset allocation is the balance between categories. You can be perfectly diversified within stocks and still be 100% in stocks. That's a high-risk allocation. You need both decisions: how much in each category, and within each category, how to spread it.
Plain-English answers from our glossary. Receipts included. Never advice.
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