Asset allocation

Asset allocation is the decision about proportions: what share of your money goes into equities, bonds, cash, property or other asset classes, and often how each is split by region. Each class has a different mix of expected return and risk. Shares have historically offered higher long-run returns with deep, sometimes lasting falls; high-quality bonds have usually offered lower returns with smaller swings; cash is stable but tends to lose ground to inflation over time. The mix is often described as a ratio, such as 60/40 for 60% shares and 40% bonds.

Studies of diversified portfolios have found that asset allocation explains most of the variation in their returns over time, more than the choice of individual funds. The right mix depends on your time horizon, your need for the money and your risk tolerance, including how you will actually behave during a fall. A common error is to set an allocation based on how you feel in a rising market. Once chosen, the mix drifts as markets move, so it needs periodic rebalancing.