Key Principle
Asset allocation — the macro split among stocks, bonds, and cash — drives 90%+ of portfolio returns, far more than individual security selection. The right allocation depends on life stage, income stability, family obligations, and time horizon — not market conditions or hot tips. Rebalance infrequently (on material drift, life changes, or approaching goal dates) to avoid tax and commission drag.
Why This Matters
Without a target allocation, portfolios drift toward whatever has performed recently — concentrating risk at exactly the wrong moment. The four life-stage model portfolios demonstrate how the equity-bond-cash split should evolve from high-growth in youth to capital preservation approaching retirement.
Good Examples
Four life-stage model portfolios (Exhibit 11.7, p. 386):
| Life Stage | Equities | Bonds | Cash |
|---|---|---|---|
| Newlywed (late 20s, $58K) | 80-90% | — | 10-20% |
| Two-income (early 40s, $115K, kids) | 60-70% | 25-30% | 5-10% |
| Single parent (34, $40K) | 50-60% | — | 40-50% |
| Pre-retirement (mid-50s, $95K) | 60-70% | 25-30% | 5-10% |
Pattern: Younger/higher-income → heavier equities. Dependents + lower income → heavier cash. Pre-retirees → ladder bonds to mature at retirement.
Manley portfolio. $98,253 invested grew to $444,774 — illustrating long-term diversified compounding. (p. 387)
Counterpoints
Over-rebalancing destroys returns. Frequent trading incurs taxes and commissions. Rebalance only on ~5% drift, life changes, or approaching goals. (p. 384)
Diversification has limits. Adding dissimilar securities reduces risk, but beyond ~15-20 holdings, additional diversification yields diminishing returns.
Key Quotes
"Unless you hold your investments for a while, transaction costs and taxes will wipe out profits." (p. 385)
Rules of Thumb
- Set allocation first (category %), then select securities within each category (p. 384)
- Rebalance when drift exceeds ~5%, life circumstances change, or goal dates approach (p. 384)
- Younger + higher income = heavier equity tilt; approaching retirement = more bonds/cash (p. 386)
- Beginners: start with balanced fund → add index fund → diversify outward (p. 385)
- Use DRPs and automatic investment plans to enforce discipline (p. 385)
- Invest regularly (monthly or per pay period) regardless of market conditions (p. 385)
- Day traders need 50-60% profits just to break even on fees — avoid day trading (p. 382)
Related References
- The Disciplined Investment Process — the disciplined investment process
- Mutual Fund Selection & Evaluation — fund selection within allocation
- Bond Fundamentals & Strategy — the fixed-income allocation component