Asset allocation: the decision that shapes everything else

Of all the decisions an investor makes, the split between asset classes is the most consequential and the least discussed.

What an asset class is

A group of instruments with similar behaviour: equities, bonds, money market, commodities. Within a class, securities correlate with each other more than with securities from another class.

Why the proportions matter more than the picks

The spread of results between equities and bonds over a period is usually wider than the spread between individual equities inside a portfolio. An error in the proportion costs more than an error in the security.

{{figure:risk-return|caption=A point below the frontier means the same risk could have been taken for a higher return}}

What the proportion depends on

The horizon — The horizon: the one parameter you cannot change by deciding to. The ability to live through a drawdown in practice rather than on a questionnaire. Whether the portfolio is being topped up or drawn down.

How it changes over time

As the goal approaches, the share of risky assets usually falls: less time remains for a recovery.

Changing the proportion because of a market forecast is no longer asset allocation but a tactical bet, and it should be judged as one.

The Russian specifics

Within the equity class, diversification here is limited by the concentration of the market — Sectors of the Russian market: what it is made of. That raises the importance of the split across classes.

Related: Rebalancing: returning to the target weights and Diversification: what it gives and what it does not.