What is asset allocation?
Asset allocation is the way a portfolio is divided between broad types of investment — asset classes — such as stocks, bonds, cash, real estate, commodities or crypto. It is the most important decision in investing: the mix of asset classes determines most of a portfolio's long-term return and nearly all of its ups and downs, far more than the choice of individual securities within each class.
How the weights are calculated
The weight of an asset class is its market value divided by the total value of the portfolio, cash included:
where is the combined value of all holdings in asset class . The weights add up to 100%.
Funds are assigned by what they hold: a world equity ETF counts as stocks, a bond ETF as bonds. A mixed fund is split according to its own allocation, where that is known.
A simple illustration
| Holding | Value | Asset class |
|---|---|---|
| World equity ETF | €42,000 | Stocks |
| Individual shares | €12,000 | Stocks |
| Government bond ETF | €18,000 | Bonds |
| Gold ETC | €3,000 | Commodities |
| Cash account | €5,000 | Cash |
The portfolio is worth €80,000 in total, so the share of stocks is:
Bonds make up 22.5%, commodities 3.75% and cash 6.25%.
Why it drives the risk
Asset classes behave very differently. Broad stock markets have historically delivered the highest long-term returns, with volatility of around 15–20% a year and drawdowns of 50% or more. High-quality bonds have returned less with much smaller swings. Cash has returned little but never fallen in nominal terms. The share of each largely fixes how much a portfolio can gain and how far it can fall.
As a rule of thumb, a portfolio's volatility and its worst drawdown scale roughly with its share of stocks. Moving from 80% to 40% stocks roughly halves both — and lowers the expected return too.
Target and actual allocation
- The target allocation is the mix an investor chooses, based on goals, horizon and tolerance for losses.
- The actual allocation drifts away from it as markets move: after a strong stock market, the stock share rises by itself.
- Rebalancing brings the actual allocation back to the target.
Things to keep in mind
- Cash is part of the allocation. Leaving it out overstates how much is invested and understates how defensive the portfolio really is.
- It is only the first layer. Two holdings can both be "stocks" and still overlap heavily. Sector, regional and currency allocation complete the picture.
A worked example
Worked through on a sample portfolio. The figures below are that portfolio’s, not yours.
What is my allocation by asset class?
Here is your allocation by asset class (top five shown first):
| Asset | Weight (%) | Value (€) |
|---|---|---|
| Stock | 49,09% | 44.666,25 € |
| ETF | 31,21% | 28.397,93 € |
| Crypto | 8,61% | 7.833,76 € |
| Cash | 6,06% | 5.510,23 € |
| Precious metal | 5,03% | 4.575,79 € |
Notes:
- The breakdown above uses the coverage available for asset-class classification.
- Your portfolio total value is 90.983,96 €.
Related topics
See these numbers for your own portfolio
Floreo works out every figure on this page from your own holdings — returns, risk, allocation, currencies — and the assistant explains them the way this page does. Import from your broker, or try it on the sample portfolio first.
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