Finance⏱ 6 min read
What Is Asset Allocation and How Do You Calculate the Right Mix?
Asset allocation — how you split money between stocks, bonds, and cash — is responsible for more of your investment returns than any individual fund or stock pick. Here's how to think about it.
Research consistently shows that asset allocation decisions (how much in equities vs bonds vs alternatives) account for 90%+ of portfolio return variation over time. Yet most investors focus far more energy on which fund to pick within each asset class.
The Core Asset Classes
Asset ClassHistorical Return (real)Risk Level
Global equities~5-6% above inflationHigh (30-50% drawdowns possible)
Government bonds~0-2% above inflationLow-medium (interest rate sensitive)
Corporate bonds~1-3% above inflationMedium
Property (REITs)~3-5% above inflationMedium-high
Cash / money market~0% above inflationVery low
Commodities / gold~0-1% above inflationHigh
The Age-Based Rule of Thumb
Classic rule: Bond % = Your age
(so at 40, hold 40% bonds, 60% equities)
Updated version (people live longer):
Bond % = Your age - 10
(at 40: 30% bonds, 70% equities)
Very aggressive version (higher risk tolerance):
Bond % = Your age - 20
(at 40: 20% bonds, 80% equities)
These are starting points — not prescriptions.
Adjust based on your actual risk tolerance and time horizon.
Calculating Expected Portfolio Return
Weighted average expected return:
= Sum of (weight x expected return) for each asset class
Example: 70% global equities, 20% bonds, 10% cash
Expected real returns: equities 5.5%, bonds 1%, cash 0%
Portfolio expected return:
= (0.70 x 5.5%) + (0.20 x 1.0%) + (0.10 x 0%)
= 3.85% + 0.20% + 0%
= 4.05% real return per year
At 4.05% real return, £100,000 grows to:
10 years: £148,900
20 years: £221,700
30 years: £330,100
(all in today's purchasing power)
Portfolio Volatility: Diversification's Dividend
Portfolio volatility is NOT a simple weighted average —
it's reduced by correlation between assets.
If equities (volatility 18%) and bonds (volatility 8%) have
correlation of -0.1 (they often move opposite directions):
Portfolio volatility (70/30):
= sqrt(0.7^2 x 18^2 + 0.3^2 x 8^2 + 2 x 0.7 x 0.3 x (-0.1) x 18 x 8)
= sqrt(158.76 + 5.76 - 6.048)
= sqrt(158.47) = 12.6%
Pure equity portfolio volatility: 18%
Blended portfolio volatility: 12.6%
Return given up: ~1.4% per year
Volatility reduction: 30%
This is the free lunch of diversification — the same
reduction in return doesn't reduce risk proportionally.
Rebalancing: Maintaining Your Target Allocation
If equities rise strongly, they become over-weighted:
Start: 70% equities / 30% bonds (£70,000 / £30,000)
After equities rise 20%, bonds unchanged:
Equities: £84,000 (77%), Bonds: £30,000 (23%)
To rebalance back to 70/30 on £114,000 total:
Target equities: £79,800 → sell £4,200 of equities
Target bonds: £34,200 → buy £4,200 of bonds
Rebalancing frequency: annually or when allocation drifts
more than 5% from target is evidence-based best practice.