Lesson 6.1 · 1 of 5 · Your portfolio
Asset allocation explained: shares, bonds, cash and what studies show
Asset allocation is how much of your portfolio you hold in shares, bonds, cash and other assets. It largely decides how much your portfolio rises and falls from one month to the next. You set it by your time horizon, the falls you can live with and when you will need the money.
Terms in this lesson
- Asset allocation
- How much of your money goes into stocks, how much into bonds and how much stays in cash.
- Bond
- A loan you make to a government or a company, at a fixed interest rate.
- Maximum drawdown
- The largest fall in price from a peak to the lowest point after it.
- Portfolio
- All your investments in one place: stocks, ETFs, bonds, cash.
What asset allocation means
In the Beginner lessons you saw why diversification helps and what shares, bonds and gold have returned since 1900. Allocation is the step above that: you decide what slice of your money goes into each type of asset before you pick any funds or shares.
They have returned the most over the long run, but have also had years of -40%. The share slice on its own largely decides how hard the portfolio swings.
Loans to governments or companies. They usually move less, but they fall too when interest rates jump, as in 2022.
Savings accounts, Treasury bills, money market funds. They hardly ever fall, but after inflation they earn little or nothing.
Some people also hold other assets: gold, property funds (REITs), commodities. These move differently from shares and bonds, but they have long falls of their own. Gold, for instance, dropped by between 17% and 33% in each of 1981, 1983 and 1984.
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Create a free accountHow much of a portfolio’s return does allocation explain
The line “asset allocation explains 90% of returns” has done the rounds for decades, and it is a misquote. In 2000, Roger Ibbotson and Paul Kaplan showed that people are really asking three different questions, and each has its own answer.
| The question | What Ibbotson and Kaplan found |
|---|---|
| How much of a fund’s ups and downs over time comes from allocation? | about 90% (median: 87.6% for mutual funds, 90.7% for pension funds) |
| How much of the difference in return between two funds comes from allocation? | about 40% (40% for mutual funds, 35% for pension funds) |
| What share of the level of return comes from allocation? | about 100%, on average |
Ibbotson and Kaplan, Financial Analysts Journal, January 2000: 10 years of monthly returns for 94 US balanced mutual funds and 5 years of quarterly returns for 58 pension funds.
Watch out
Why doesn’t “100%” mean choices don’t matter?
Because, on average, the funds’ choices added nothing on top of the basic mix.
The third row compares a fund’s return with what it would have earned just by holding its basic mix in index funds. On average, the funds did not beat it: after fees and other costs, their choices and the timing of their trades added nothing. For any one fund, though, its choices can mean a lot more or a lot less. The second row shows exactly that: 60% of the differences between funds did not come from allocation.
How far mixes of shares and bonds have fallen in the past
Columns showing the biggest fall from one year-end to another, 1928-2025, for mixes of US shares and bonds rebalanced each year: 100% shares -64.8%, 80/20 -53.5%, 60/40 -40.1% (all between 1928 and 1932), 40/60 -25.6%, 20/80 -17.9% (in 2022).
| The mix | Return a year | Worst year | Years down |
|---|---|---|---|
| 100% shares | 10.0% | -43.8% (1931) | 26 of 98 |
| 80% shares, 20% bonds | 9.3% | -35.6% (1931) | 25 of 98 |
| 60% shares, 40% bonds | 8.3% | -27.3% (1931) | 21 of 98 |
| 40% shares, 60% bonds | 7.2% | -19.1% (1931) | 20 of 98 |
| 20% shares, 80% bonds | 6.0% | -17.9% (2022) | 15 of 98 |
Our calculation, 1928-2025, from the annual returns published by Aswath Damodaran (NYU Stern): the S&P 500 with dividends and 10-year US Treasury bonds, rebalanced at the end of each year. In US dollars, before inflation, costs and tax. Past results may not be repeated.
The chart and the table use annual data: the falls run from one year-end to another, so they understate what was actually lost. Within the years the falls were deeper: the S&P 500 index fell 56.8% on closing prices between 9 October 2007 and 9 March 2009, although its worst calendar year was 2008, at -36.55% (with dividends).
How to choose an allocation: time horizon, risk and when you need the money
- When will you need the money?A house deposit in two years can’t wait for a recovery after a 40% fall. A pension pot you’ll draw in 25 years can.
- What fall could you sit through without selling?Think in pounds, not percentages: 30% of £100,000 is £30,000 less on the screen. Selling in a panic turns a fall into a loss.
- Do you have an emergency fund?If losing your job or a big repair forces you to sell shares in a bad year, your real allocation is riskier than it looks on paper.
Lessons are educational. They are not a recommendation to buy or sell. Investing involves risk and you can lose money. Sources: G. Brinson, R. Hood and G. Beebower, “Determinants of Portfolio Performance”, Financial Analysts Journal, 1986 (91 US pension funds, 1974-1983, average R² of 93.6%), as described in R. Ibbotson and P. Kaplan, “Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?”, Financial Analysts Journal, vol. 56, no. 1, January 2000; annual returns for 1928-2025 of the S&P 500 with dividends, 10-year US Treasury bonds and gold from Aswath Damodaran’s data set (NYU Stern, updated 5 January 2026), with our own calculations for the mixes; S&P 500, high of 9 October 2007 and low of 9 March 2009. The example portfolios are illustrative, not recommendations.