Basic Asset Allocation Models For Your Portfolio (2024)

Asset allocation refers to the mix of investments in a portfolio. It describes the proportion of stocks, bonds and cash that make up any given portfolio—and maintaining the right asset allocation is arguably the most important decision long-term investors can make.

As Jack Bogle, the founder of Vanguard, put it: “The most fundamental decision of investing is the allocation of your assets: How much should you own in stocks? How much should you own in bonds? How much should you own in cash reserve?”

Stocks and bonds offer contrasting advantages and disadvantages. History tells us that over the long run stocks havea higher rate ofreturn than bonds. Since 1926, stocks have enjoyed an average annual return almost twice that of bonds.At the same time, stocks come with more volatility.Bonds in a portfolio reduce the volatility, but at the cost of lower expected returns.

This dynamic can make the decision between stock and bond allocations seem difficult. In this article, we’ll look at asset allocation models from two perspectives: First, we’ll consider the stock-to-bond allocation and its effect on a portfolio’s volatility and returns. Second, we’ll look at specific investment portfolios that any investor can use to implement the asset allocation they ultimately choose.

Keep in mind that an asset allocation plan involves more than just stocks and bonds. Within the stock allocation, for example, one may consider geography (U.S. vs. international stocks), market capitalization (small companies vs. large companies) , and alternatives (e.g., real estate and commodities). We will consider some of these asset classes in our model portfolios below.

Basic Asset Allocation Models

As noted above, the single most important decision an investor can make is the allocation between stocksand bonds. Based on a vast amount of historical data, we know how different allocations between stocks and bonds behave over long periods of time.

100% Bond Portfolio

Vanguard offers dataon the historical risk and return of various portfolio allocation models based on data from 1926 to 2018. For example, a portfolio consisting of 100% bonds has experienced an average annual return of 5.3%. Its best year, 1982, saw a return of 32.6%. It fell 8.1% in its worst year, 1969. Of the 93 years of historical data cited by Vanguard, a 100% bond portfolio lost value in 14 of those years.

100% Stock Portfolio

At the other extreme, a 100% stock portfolio had an average annual return of 10.1%. Its best year, 1933, saw a 54.2% return. Its worst year, just two years earlier in 1931, experienced a decline of 43.1%. The portfolio lost value in 26 of the 93 years covered by Vanguard’s analysis.

Comparing these two extreme portfolios underscores the pros and cons of both stock and bond investments. Stocks over the long term have a much higher return, but the stock-only portfolio experienced significantly more volatility. The decision investors need to make is how much volatility they can stomach, while also considering the returns they need to meet their financial goals.

Income, Balanced and Growth Asset Allocation Models

We can divide asset allocation models into three broad groups:

• Income Portfolio: 70% to 100% in bonds.

• Balanced Portfolio: 40% to 60% in stocks.

• Growth Portfolio: 70% to 100% in stocks.

For long-term retirement investors, a growth portfolio is generally recommended. Whatever asset allocation model you choose, you need to decide how to implement it. Next up, we’ll look at three simple asset allocation portfolios that you can use to implement an income, balanced or growth portfolio.

3 Easy Asset Allocation Portfolios

There are any number of asset allocation portfolios one could create to implement an investment plan. Here we’ll keep it simple, and look at three basic approaches. While they increase in complexity, all are very easy to implement.

The One-Fund Portfolio

You can implement an asset allocation model using a single target-date fund. Most 401(k) plans offer target-date retirement funds, which accomplish two important tasks.

First, they take an investor’s money and divide it among a number of diversified mutual funds. These funds include both bond and stock investments. They generally include investments in domestic and international stocks and bonds, and in small and large companies.

Second, as an investor nears retirement, the target-date retirement fund gradually shifts the asset allocation in favor of fixed-income investments such as bonds. This reduces the volatility of the portfolio as the investor nears the time he or she will need to start to rely on the portfolio to cover living expenses in retirement.

Target-date funds are generally classified by the year in which the investor plans to retire. For example, an investor who plans to retire in about 35 years might choose the Vanguard Target Retirement 2055 fund (VFFVX).This fund invests in both a U.S. stock and international stock mutual fund, as well as both U.S. and international bond funds. Its asset allocation model today is approximately 90% stocks and 10% bonds and short-term reserves. Of course, this allocation will begin to shift in favor of bonds as we get closer to 2055.

Keep these three points in mind when considering target-date funds:

• Target-date fund fees can be expensive. While the target date retirement funds at Vanguard are reasonably priced, some mutual fund companies charge in excess of 50 basis points.

• Target-date funds may not be suitable for a taxable account. Because target-date retirement funds include bonds and other fixed-income investments, they may not be well suited for a taxable investment account.

• There’s no requirement to invest in a target-date fund that matches the year you plan to retire. If you prefer a different asset allocation model, you could find a target-date retirement fund that matches your model of choice, regardless of the year you plan to retire.

The 2-Fund Portfolio

If you’d like more control over your asset allocation, consider a two-fund portfolio. With just two well-diversified index funds, you can create an excellent investment portfolio.

For example, you could put your stock allocation into a total market index fund that covered both U.S. and international companies. You could then put the portion allocated to bonds in a total bond index fund. This portfolio makes it extremely easy to implement the stock/bond allocation you prefer.

Using Vanguard mutual funds as an example, here are two funds one could use to implement a two-fund portfolio:

• Vanguard Total World Stock Index Fund (VTWAX)

• Vanguard Total Bond Market Index Fund (VBTLX)

At first glance such a portfolio might not seem to offer enough diversification. The Vanguard Total World Stock Index Fund, however, invests in over 8,400 companies. Further, these companies are headquartered throughout the world. Likewise, the Vanguard Total Bond Market Index Fund invests in over 9,000 bonds. In short, even this two-fund portfolio is well-diversified.

The 3-Fund Portfolio

For even more control over your allocation, check out a three-fund portfolio. With this model portfolio, the stock allocation is divided between two mutual funds, one covering U.S. equities and the other covering international equities. This provides additional control over how much of the stock allocation goes to U.S. companies and how much is invested in overseas firms.

Using Vanguard mutual funds, the three fund portfolio could be implemented with the following mutual funds:

• Vanguard Total Stock Market Index Fund (VTSAX)

• Vanguard Total International Stock Index Fund (VTIAX)

• Vanguard Total Bond Market Index Fund (VBTLX)

Other mutual fund providers offer similar index funds that may be used to implement the three-fund portfolio. Fidelity, for example:

• Fidelity Zero Total Market Index Fund (FZROX)

• Fidelity Zero International Index Fund (FZILX)

• Fidelity U.S. Bond Index Fund (FXNAX)

Most major mutual fund companies offer similar index funds and target-date retirement funds that one could use to implement any of the three portfolios above.

Keep an Eye on Fees

As you decide on your asset allocation model and implement that model, keep in mind the importance of investment fees. Even a fee of 50 basis points could reduce your returns over a lifetime of investing. As a general rule, aim to keep your investment expenses to no more than 25 basis points, and fewer than 10 basis points is preferred.