When you’re building your portfolio, you’ll have a lot of choices about what to buy. You’ll also have to decide how much of each investment to own. This exercise is called asset allocation, and it’s one of the more important decisions you will make as an investor.
Different types of investments behave differently, and can play various roles in a portfolio. For example, stocks tend to offer higher return potential over the long-term, but can also swing up and down in value (this is known as volatility). Bonds tend to offer smoother returns than stock, though typically lower over the long-term. Cash is the most stable, but it doesn’t grow much. There are other asset classes with unique characteristics, as well, including commodities, real estate, and alternative investments. Combining these assets in the right proportions is important to build a portfolio that fits you — your goals, your timeline, and your comfort with risk. That’s asset allocation.
There is no one-size-fits-all approach, because everyone’s situation is different. To figure out your ideal allocation, it helps to think about your time horizon and your relationship with risk: your risk tolerance (how much volatility you're comfortable with), risk capacity (whether your financial situation can handle the ups and downs), and risk requirement (how much growth you need to meet your goals).
It’s tempting to bet big on something that looks promising — a hot stock, a fast-growing sector, or one part of the world’s market — but putting all your eggs in one basket can lead to a wide range of possible outcomes. Sure, things might go well, but they could also go very wrong. Diversifying across asset classes, sectors, and regions helps narrow the range of outcomes by holding investments that may behave in different ways. This strategy doesn’t guarantee a big win, but it reduces the chances of a big loss — and that stability can help you stay the course, even when headlines get noisy.
Asset allocation changes over time. When you’re younger, you usually have time to ride out market dips, so a portfolio tilted more toward growth (like stocks) can often make sense. As you get closer to your goal — whether it’s retirement, buying a home, or something else — you might want to shift toward more stable investments to protect what you’ve built. This idea of gradually adjusting your mix over time is a key part of long-term investing, and it’s something many professionally managed portfolios often do automatically.
Once you've established your ideal asset allocation, market movements will naturally push your portfolio away from those targets over time, as different investments grow at varying rates. Rebalancing is the process of bringing your portfolio back in line with your target allocation by selling portions of investments that have grown beyond their intended percentage and buying more of those that have fallen below target. This disciplined approach serves two important purposes: it manages risk by preventing overexposure to any one asset class, and it enforces a "buy low, sell high" strategy that can be psychologically difficult but financially beneficial. Whether you choose to rebalance on a regular schedule (annually or semi-annually), when allocations drift beyond predetermined thresholds (like 5%), or through automatic services offered by many platforms, the key is consistency. Having a plan and sticking to it is vital, especially during market volatility, when emotions might lead you astray.
Creating and maintaining a diversified portfolio can be tricky if you're picking individual investments yourself. But there are easier ways to get there. Many investors use exchange traded-funds (ETFs), which are baskets of investments designed to offer diversification at a low cost (such as “all-in-one” ETFs). It’s important to focus on the low cost part, though — be careful you aren’t impacting your potential returns by overpaying on expensive management fees.
