Asset Allocation

The decision that outweighs all the others

Investors agonize over which fund or stock to buy, but the research on portfolio outcomes keeps pointing at a less glamorous culprit: the split itself. Studies of long-term portfolios find that asset allocation explains most of the variability of returns over time. Whether you held 80% stocks or 40% stocks mattered far more than which stocks they were.

That is oddly liberating. Get the split roughly right for your situation, fill each slice with cheap diversified funds, and the hard part of investing is done. Get the split wrong, and no amount of clever picking inside it will fix the mismatch.

What each slice is for

Each asset class has a job, and the mix is really a division of labour.

• Stocks grow. They own the world's businesses and deliver the highest long-run returns, at the price of stomach-churning swings along the way. They are the engine.
• Bonds stabilize and pay income. A bond is a loan that pays interest and returns your principal, so bond prices swing far less than stocks and often hold up when stocks fall. They are the brakes and the shock absorbers.
• Cash is for near-term needs. Savings accounts and GICs barely grow, but they cannot crash. Money you will spend soon belongs here, not in markets.

Classic starting points: 60/40 and age in bonds

The most famous allocation is the 60/40 portfolio: 60% stocks, 40% bonds. It is not magic, just a durable compromise that captures most of the stock market's growth while cutting the depth of its crashes roughly in half. It has been declared dead many times and keeps not dying.

An older rule of thumb says to hold your age in bonds: 30% bonds at 30, 60% at 60. Its logic is sound, since your runway to recover from crashes shrinks as you age, but the formula itself has aged poorly. With retirements now commonly lasting 25 or 30 years, a 65-year-old with 65% bonds may be too conservative for a portfolio that still has to grow for decades. Treat age-based rules as a rough sanity check, not a prescription.

Matching the mix to your life

The right allocation comes from two personal inputs. The first is risk tolerance: the drop you can watch on your statement without selling. An 80/20 portfolio is only right for you if you can hold it through a crash, because the allocation you abandon at the bottom is worse than a milder one you keep.

The second is time horizon. Money needed within about 5 years does not belong in stocks at all, because markets can stay down longer than your deadline can wait; that money belongs in cash and GICs. Money with a 10-year-plus runway can afford heavy stock weightings, since it has time to ride out full market cycles. Most people have several horizons at once: a house fund on a 3-year clock and retirement money on a 30-year clock should not live in the same mix.

Asset allocation ETFs: the Canadian one-fund solution

Canada's fund industry turned this entire article into a single product: the asset allocation ETF, offered by Vanguard, iShares, BMO and others. One ETF holds a complete global portfolio of stocks and bonds at a fixed mix, in variants running from conservative blends through balanced 60/40 to all-equity, and it rebalances itself back to target automatically. You pick the mix once and buy one ticker forever.

Their quiet genius is behavioural. The biggest beginner failures were never stock-picking errors; they were never rebalancing at all, and panic tinkering with the mix at the worst moments. An asset allocation ETF removes both failure modes by welding the portfolio shut: the rebalancing happens inside the fund, and there are no slices visible to tinker with. For many Canadians, choosing the right one of these is the entire investment plan.

Glide paths: allocation is a dial, not a setting

Your allocation should drift deliberately as goals approach, a schedule the industry calls a glide path. Retirement money might sit at 90/10 in your 30s, slide toward 60/40 through your 50s, and settle somewhere near half stocks in retirement, since the money still has to outgrow decades of inflation. The same idea applies to any dated goal: an education fund or house fund should get steadily more conservative as the spending date closes in, ending in cash. The mistake is not any particular schedule; it is reaching the goal line still fully exposed to a crash.