How To Choose The Right Asset Allocation

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Asset allocation is a fancy term for your mix of investments. We're talking about how much of your portfolio is in stocks versus bonds versus real estate versus cash versus alternative kinds of investments. That's your asset allocation, right? These are all assets, and this is how you allocate them.

Now, some people use a tactical asset allocation, where they're changing that mix of investments, trying to time the market and figure out which one is going to do best going forward. I'm not a big fan of that technique because I've found my crystal ball is not very functional, and so I need an investing technique that is going to work no matter what the markets do. That doesn't require me to be able to predict the future in order to be successful, and that's called a static asset allocation. So you actually decide what percentage of your portfolio is going to go into each type of investment, each asset class. They're called like international stocks, or U.S. stocks, or small value stocks, or real estate, or tips bonds, or regular nominal bonds. Right? You decide up front what percentage of your money is going to go into each of these types of investments, and then all you have to do is maintain those percentages.

But it turns out when people study this, the actual mix of investments, the asset allocation, matters more than the individual investments you pick. It's not about whether you pick Nvidia versus Amazon, or it's not whether you pick, you know, a Schwab index fund versus a Vanguard index fund. We get focused on that stuff too much. What really matters is the overall mix of investments. How much is going into stocks? How much into bonds? How much into real estate? That drives something like 80 or 90% of your returns, rather than the actual investments that you choose. So try to zoom out a little bit and focus on the forest and not the trees.

It's important to recognize that risk and return are connected here. Now you don't always get a higher return for taking on more risk. You want risk that you're compensated for, right? Just gambling with your money is very risky, but that doesn't necessarily have a higher expected return. But getting higher expected returns generally do require you taking on more risk. It is a necessary but not sufficient condition for higher returns, if you will.

Now, the downside of higher risk investments is not only volatility, where the value of the investment goes up and down over time, but also the actual risk of loss in the long run can be higher as well. And so it's a bit of a trade-off. If you want to take less risk, you're going to need to save more money because you're not going to have as high of a return on the money. If you take on a little bit more risk, maybe you can get away with saving a little bit less money, which is obviously very attractive to lots of people. So you're balancing your ability to deal with that volatility and the risk of real loss with the benefit of possibly being able to save less and still being able to reach your goals or being able to reach your goals a little bit faster.
So, how do you set your asset allocation? You do it by determining your need, your ability, and your willingness to take risk. Okay. For example, you might run the numbers and calculate that you need 9% returns to reach your financial goal in 10 years from now. That's going to require you to take a significant amount of risk.

Then, if you run the numbers and you find you only need 3% returns in order to reach your goals, well, the person who needs 9% returns has a lot higher need to take risk.

Ability to take risk refers to a few things. It refers to your risk tolerance, your emotional makeup that allows you to tolerate that volatility of your investments going up and down in value. It also reflects your practical ability to deal with downturns. You know, for example, when you have a larger emergency fund, a larger chunk of money sitting in cash, you have a greater ability to take risk with the rest of your portfolio.

So we talked about your need and your ability, and sometimes you know your willingness to take risk also affects it. For example, imagine somebody that's very, very wealthy compared to how much they spend. Let's say they have $10 million and they only spend $150,000 a year in retirement. Right. This is the sort of person that it really doesn't matter what their asset allocation looks like. Any asset allocation is going to allow them to spend $150,000 of 10 million with pretty much zero chance of ever running out of money. So that person is then asked, "What's your willingness to take risk? You know, what are you going to do with?" Extra money that comes from your portfolio having higher returns. Are you going to be able to leave more to charity? You're going to leave more to your heirs. Maybe you're more willing to take risk, more risk than you actually need to, to reach your goals. So you have to determine your need, and your ability, and your willingness to take risk.

Okay. So the core building blocks for most portfolios is a risky asset class, usually stocks. Right, these are shares of the most profitable companies in the history of the world, and bonds. You know, a safer investment that pays a fixed amount of income. You know, these could be substituted for cash or CDs or something like that. But generally, stocks and bonds are the two basic building blocks. The stocks provide the growth because they generally have higher long-term returns, and the bonds provide stability and income and help reduce how volatile that portfolio is.

And so you can change that mix, that stock to bond ratio. It could be 90% stocks, or it could be 25% stocks. The 25% stock portfolio is probably going to have lower long-term returns, but it's going to be dramatically less volatile and less risky as far as long-term loss goes.

Now, obviously, the lower your returns, the less likely you are to reach goals, especially if you need high returns to reach those goals. And you know, and inflation, of course, is also going to have a more substantial impact on a portfolio with lower returns. So that's a pretty individual decision: how much money you put into stocks and bonds, and can be challenging for a lot of people to come up with. But the truth is, if you pick something reasonable, and reasonable for most people means something like 50 to 90% of your portfolio in riskier investments like stocks and real estate. That's probably about where you need to be.

It's important to be diversified. You want to be diversified between asset classes, stocks, bonds, real estate, etc. as well as within an asset class. So I generally recommend people have at least three asset classes in their portfolio. There are probably some significant benefits in going as high as seven. Maybe there's some minor benefits as you go into eighth, ninth, and 10th asset classes. Beyond that, you're clearly just playing with your money. Okay, so at least three, no more than 10, is my guideline as far as how many asset classes belong in your portfolio, and within each of those, you need to be diversified enough that if one investment gets wiped out, if one of your you know private real estate investments goes to zero, it's not going to have a substantial effect on your portfolio.

Within publicly traded assets like stocks and bonds, you can own 1,000s of them. When you buy a total U.S. stock market index fund, you're buying 3500 or 4000 different stocks. If one of them goes to zero, even if it's Google or Nvidia or Amazon or something like that, it's really not going to have a big effect on your overall return. And so that's a that's a wonderful thing about being diversified, and it matters. Diversification matters. Don't put all your money into one real estate property. Don't put all your money into one stock. Don't put all your money into a cryptocurrency or something like that. Right? When you hear financial tragedies, often they're caused by a portfolio that just wasn't diversified. Someone was essentially gambling, not investing.

One of the most important aspects of your asset allocation is that you have to be able to stick with it.

Nobody can know in advance what the exact perfect right asset allocation is, so you need to pick something reasonable and stick with it. You know, whether you invest some money into real estate or whatever, real estate will have a stay in the sun, right? But it's going to have some bad years too, where stocks and bonds outperform it, and you're going to go, ah, why do I even have this real estate in here? But it's important in the long run. You have the static asset allocation that you rebalance back to those percentages each year, that you can stick with it. You are the most important part of your investment plan. The biggest risk to your plan is the person looking back at you in the mirror every morning. Your own behavior is the biggest risk. So, the most important thing when choosing an asset allocation is choosing one you can stick with, one you're not going to get FOMO about and go making it more risky at just the wrong time, or one that you panic sell when the market goes down in value, it needs to be an asset allocation that you can stick with, and don't fall into the trap of performance chasing.

So many people, when they put their asset allocation together, they look at what did great the last two or three or four years, and they don't realize that there are cycles in all things, right? So a lot of people in in 2026 when they're putting together portfolios after five or 10 years of large U.S. growth tech stocks outperforming, they have a lot of those in their portfolio. Whereas somebody who put a portfolio together in 2010, after a decade of those stocks doing very poorly, might not. Very many of those at all, so be careful about performance chasing. Really try to take a long-term perspective, and not just focusing on recent winners that are likely to disappoint you if you're arriving late to the party.

And don't forget, of course, to rebalance the portfolio periodically. You know, studies show that you don't have to do this very often. Every 123, years is probably plenty often, and try to do it inside tax-protected accounts like 401ks and Roth IRAs and those sorts of accounts, so you don't have to pay any tax costs for that rebalancing.

But rebalancing allows you to bring the portfolio back to your desired risk level. No matter what is done well in the last year, you're back to where you started at the end of the year, as far as your percentages. Hopefully, it's significantly higher amount in the account, but the percentages are back where you started them.

And remember this: there is no perfect portfolio. Settle on good enough. That's what you're looking for, and then fund it adequately, and it's highly likely to allow you to reach your financial goals.

The White Coat Investor Podcast is for your entertainment and information only, and should not be considered financial, legal, tax, or investment advice. Investing involves risk, including the possible loss of principal. You should consult the appropriate professional for specific advice relating to your situation.