Asset Allocation: Choosing Your Mix of Stocks and Bonds

Before you choose a single fund, you face a bigger decision: how much of your money goes into stocks, how much into bonds, and how much stays in cash. That split, your asset allocation, decides how far your portfolio can fall in a bad year and roughly how fast it can grow over decades. Most people never choose it on purpose. They end up with whatever a default, a friend or last year's headlines handed them, and they find out what it really means in the middle of a crash. This chapter shows how to choose it deliberately.

Why the mix matters more than the picks

You will often read that asset allocation "explains 90% of your returns". That figure comes from a 1986 study of large pension funds by Brinson, Hood and Beebower, and it is usually misquoted. What the study found is that the policy mix explained about 90% of how a fund's returns moved up and down from quarter to quarter. It did not say the mix decides 90% of how much money you end up with. A later study by Ibbotson and Kaplan in 2000 untangled the two questions: across funds, the mix explains a smaller share of why one fund beat another, but over time it explains nearly all of the ride a single investor experiences.

The practical point survives the correction. If you own broad, low-cost funds, the choice of which fund matters far less than the share you hold in stocks. Two portfolios built from different stock index funds will feel almost identical. A portfolio that is 90% stocks and one that is 40% stocks will not.

Each asset class does a different job:

• Stocks are ownership in companies. They are the growth engine and the main source of risk. Over the long US record, large-company stocks grew at 10.02% a year before inflation and 6.78% after it, from 1928 to 2025.
• Bonds are loans to governments and companies. They pay interest and usually fall less than stocks. The 10-year US Treasury bond returned 4.53% a year before inflation over the same period.
• Cash (savings accounts, money market funds, Treasury bills) holds its value in dollars and is there for spending you can see coming, not for long-term growth.

What a bad year looks like at each mix

Averages hide the experience. The question that decides whether you stick with a plan is what happens in the worst years. In the record from 1928 to 2025, US large-company stocks lost 43.84% in their worst calendar year, 1931. A mix of 60% stocks and 40% Treasury bonds, rebalanced each January, lost 27.33% that year. Here is what those falls do to the same starting balance.

A portfolio of $100,000 fully in stocks ends that year at $56,160. The 60/40 mix ends at $72,670. Falls over several years can go further: from the end of 1928 to the end of 1932, all-stock portfolios lost 64.77% from their peak, the 60/40 mix 40.06%.

The price of the smoother ride is slower growth. Over the same 98 years, the 60/40 mix grew at 8.34% a year before inflation and 5.15% after it. Over a working life the gap compounds.

Saving $500 a month for 30 years, the all-stock history would have ended near $561,548 in today's dollars and the 60/40 history near $418,623. Both started from the same $180,000 of contributions. Neither number is a forecast: future returns may be lower or higher than the past, and nobody gets the average every year.

Bonds do not always cushion the fall

The case for bonds rests on the idea that they hold up when stocks fall. Often they do. In 2008, US large-company stocks lost 36.55% while the 10-year Treasury gained 20.1%, and a portfolio holding both fell far less than an all-stock one.

But the relationship is not a law. In 2022, with inflation high and interest rates rising fast, stocks lost 18.04% and the 10-year Treasury lost 17.83% in the same year. Bond prices fall when interest rates rise, and longer-dated bonds fall more. Short-term bonds, Treasury bills and inflation-protected Treasury securities (TIPS) behave differently from long-term bonds, which is why the bond side of a portfolio deserves its own thought. Volume 1 on this shelf covers how bonds work.

How people choose a mix

There is no correct allocation, only one that fits your situation. Three questions do most of the work.

When will you spend the money? Money needed within a few years usually does not belong in stocks at all, because a fall of the size shown above may not recover in time. Money for a goal decades away can ride out several crashes.

How much risk can you afford? This is your capacity: a stable income, other assets, a pension or Social Security that covers basic costs, and a solid emergency fund all raise how much stock risk you can carry without being forced to sell.

How much risk can you stand? This is your tolerance, and it is best tested against dollars, not percentages. Multiply your portfolio by the worst-year losses above and ask whether you would keep investing, sit tight, or sell. Selling after a fall turns a temporary loss into a permanent one, so a mix you can hold through a crash beats a higher-returning mix you would abandon.

Several rules of thumb give a starting point:

• "100, 110 or 120 minus your age" in stocks. At 40, that gives 60%, 70% or 80%. The higher versions reflect longer lives and lower bond yields than when the rule began.
• Target-date funds follow a glide path set by the fund company. Large providers typically hold around 90% stocks for savers decades from retirement, falling to roughly half by the target year. Paths differ between companies, so read the fund's own description.
• Model mixes such as 80/20, 60/40 or 40/60 are often labelled growth, balanced and conservative.

Each is a starting point to adjust for the three questions, not an answer.

Set it and hold it, or adjust as you go

A strategic allocation fixes target percentages and restores them through rebalancing, changing them only when your life changes: a new goal, a shorter horizon, a large inheritance. A tactical allocation shifts the mix on a view of where markets are heading. Tactical moves require you to be right twice, about when to leave and when to return, and research on professional managers who try it is not encouraging. For most savers, a strategic mix that steps toward bonds as the spending date approaches is easier to follow and harder to get badly wrong.

Count every account when you measure your mix: a 401(k), IRAs, a taxable brokerage account and a partner's accounts all hold one household's risk. Chapter 5 covers keeping the mix on target, and chapter 4 covers how much of the stock side to hold outside the US.