What Is Asset Allocation? Stocks, Bonds and Cash, Drift and Rebalancing

Asset allocation is how a portfolio's money is divided among broad asset classes such as stocks, bonds and cash, each stated as a share of the total value.

A portfolio described as "60/40" is an asset allocation: 60 percent in stocks and 40 percent in bonds. This page explains what counts as an asset class, how an allocation is measured, why it drifts as prices move, what rebalancing means with a worked example, how target-date funds change their mix over time, and what the research on allocation and returns actually found. It is descriptive throughout.

What asset allocation means

The SEC's investor education site, Investor.gov, defines asset allocation as dividing investments among different categories, such as stocks, bonds and cash. Its beginners' guide calls these the three major asset categories and describes how they differ:

• Stocks have historically carried the greatest risk and the highest returns of the three, with large swings in the short term.
• Bonds have tended to swing less than stocks and to return less.
• Cash and cash equivalents, such as savings deposits, Treasury bills and money market funds, have the lowest risk of loss and the lowest return, with inflation the main risk.

The same guide lists other categories some portfolios hold, including real estate, precious metals and other commodities, and private equity, each with risks of its own.

The guide also names the two inputs it describes as shaping an allocation: the time horizon, how long until the money is needed, and risk tolerance, the ability and willingness to accept losses in exchange for potentially higher returns. It describes the choice as a personal one, with no single mix right for every goal.

How an allocation is measured

An allocation is measured by market value, not by what was paid. Each holding's current value is divided by the portfolio's total value, and holdings are grouped by asset class. A portfolio worth $100,000 with $60,000 in a stock fund and $40,000 in a bond fund is 60/40 today, whatever the purchase prices were.

Two details matter in practice. A fund is classified by what it holds: a bond ETF (exchange-traded fund) is part of the bond allocation even though it trades on a stock exchange like a share. And allocation can be measured along other lines too, such as sector, country or currency, which describe a different side of the same portfolio.

Drift: why an allocation changes on its own

Because the weights are based on market value, an allocation moves every time prices do, with no trade at all. This is called drift.

A worked example. A $100,000 portfolio starts at 60/40: $60,000 in stocks and $40,000 in bonds. Over the next period stocks rise 25 percent and bonds rise 2 percent.

The portfolio is now about 65/35, without a single trade. If stocks had fallen instead, the stock weight would have shrunk below 60 percent. Over long periods, the asset that rises most takes a growing share of the portfolio.

Rebalancing

Rebalancing means bringing a portfolio back to its target mix. Investor.gov's guide describes three ways it is done:

1. Selling part of the overweight asset and buying the underweight one. In the example, 60 percent of $115,800 is $69,480, so moving $5,520 from stocks to bonds restores 60/40. 2. Buying only the underweight asset with money from outside the portfolio. 3. Directing new contributions to the underweight asset until the mix is back near target. In the example, a new $10,000 placed entirely in bonds brings the portfolio to $125,800, split 59.6 percent stocks and 40.4 percent bonds.

The guide also describes two common schedules: rebalancing at regular intervals, such as every six or twelve months, or only when an asset class moves more than a set percentage away from its target. It also notes that the method chosen can trigger transaction fees or tax consequences.

Strategic, tactical and target-date allocation

The terms below describe different ways an allocation is set and changed over time.

• Strategic allocation is a long-term target mix, such as 60/40, kept in place through rebalancing and changed only when the goal, horizon, risk tolerance or financial situation changes.
• Tactical allocation describes temporary departures from that long-term mix based on a view about markets. Whether such departures add value is a long-running debate, and the outcome depends on the view being right.
• Target-date funds, which Investor.gov's guide calls lifecycle funds, automatically shift toward a more conservative mix as a chosen year approaches (in many funds the shift continues after that year), and the fund's managers make the allocation and rebalancing decisions. The year in the fund's name, such as 2045, is the target date. The path the mix follows over time is called the glide path, and it differs from one fund family to another.

Seeing an allocation in Kresmion

Kresmion's portfolio Analytics tab shows a portfolio's Exposure split four ways, by asset class, sector, country and currency, as a share of weight or of value. One limit is worth knowing before reading it: the asset-class panel groups any fund entered by ticker with stocks under "Stock / ETF", whatever the fund holds, so a bond ETF does not appear as bonds there. The same tab can compare the portfolio's performance with a 60/40 benchmark, built as 60 percent SPY (an S&P 500 fund) and 40 percent AGG (a broad US bond fund) and rebalanced daily, alongside single-fund benchmarks such as SPY and ACWI (a global stock fund). The portfolio pages need a Kresmion account, and the calculations run in the browser.

Kresmion's public macro regime page gives one descriptive daily reading of the cross-asset conditions an allocation sits in: a label from Strong Risk-On to Strong Risk-Off and the composite score behind it. It describes conditions that have already been measured. It is not an allocation signal and does not say what any portfolio holds or ought to hold; what a macro regime score is explains how it is built. How closely different assets have moved together, the property that makes mixing them matter, is covered in what correlation in markets is.

Honest limitations

The worked example ignores fees, taxes and the timing of trades, all of which change real results. Asset class labels are a simplification: a high-yield bond fund, which holds lower-rated company debt, can behave more like stocks than like Treasuries, and a single stock can hold most of a stock allocation. The research on allocation and returns, covered in the FAQ below, measures averages across funds over particular periods, and its figures depend on the funds and years studied. Kresmion's exposure panels report what the holdings entered into the portfolio are, so their accuracy depends on that input, and the ETF grouping above means they show some allocations less precisely than a fund-by-fund breakdown would.

Key takeaways

Frequently asked questions

What is a 60/40 portfolio?

A portfolio with 60 percent of its value in stocks and 40 percent in bonds. It is a common reference mix and is often used as a benchmark for balanced funds. The 60/40 split describes the target; actual weights drift between rebalancings.

Does asset allocation explain 90 percent of returns?

That figure is often quoted out of context. Roger Ibbotson and Paul Kaplan, writing in the Financial Analysts Journal in 2000, separated three questions. Using balanced mutual fund and pension fund data, they found that policy explained about 90 percent of the variability of a typical fund's returns over time, about 40 percent of the variation of returns among funds, and on average about 100 percent of the return level. The answer depends on which question is asked. The 90 percent figure is usually traced to a 1986 study of large US pension plans by Gary Brinson, Randolph Hood and Gilbert Beebower, the debate Ibbotson and Kaplan set out to settle.

What is the difference between asset allocation and diversification?

Asset allocation is the split between asset classes. Diversification is the spreading of money across many investments to reduce the effect of any one of them, which can happen within an asset class as well as between classes. Investor.gov's guide notes that an allocation entirely in one class, such as all stocks, is still an allocation but does not spread risk across classes.

How often are portfolios rebalanced?

There is no single rule. Investor.gov's guide describes rebalancing on a calendar, such as every six or twelve months, or when a weight moves past a set threshold, and it notes that transaction fees and taxes are part of the trade-off.

Is the Kresmion macro regime an allocation signal?

No. It is a descriptive daily reading of cross-asset conditions that have already been measured. It does not forecast markets, and it does not say how any portfolio is or ought to be allocated.

This page is information, not investment advice.

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Source: Investor.gov (US Securities and Exchange Commission), "Beginners' Guide to Asset Allocation, Diversification, and Rebalancing", https://www.investor.gov/additional-resources/general-resources/publications-research/info-sheets/beginners-guide-asset ; Investor.gov glossary entry "Asset Allocation", https://www.investor.gov/introduction-investing/investing-basics/glossary/asset-allocation ; Roger G. Ibbotson and Paul D. Kaplan, "Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?", Financial Analysts Journal 56(1), 2000, abstract at https://ideas.repec.org/a/taf/ufajxx/v56y2000i1p26-33.html ; drift and rebalancing figures computed by Kresmion for a hypothetical portfolio ; Kresmion portfolio analytics (exposure panels and benchmarks, account required) and the Kresmion macro regime page.

Kresmion Research.