Strategie
How to Combine Equities, Bonds, and Cash: Asset Allocation Over Time
Key takeaways
- Asset allocation determines the return and risk profile of a portfolio more than the choice of specific funds.
- At a young age a higher equity allocation makes sense — time compensates for volatility.
- As a goal or retirement approaches, the allocation becomes more conservative — the equity share decreases.
- Cash and short-term bonds serve as a safety cushion and a source of withdrawals.
- Rebalancing returns the portfolio to its target allocation and involves selling dear and buying cheap.
Asset allocation — the share of equities, bonds, and cash in a portfolio — is one of the most important decisions for every investor and has a greater influence on results than the choice of specific funds.
Why the mix matters more than the selection
The famous Brinson, Hood, and Beebower study from 1986 showed that roughly 90% of the variability in portfolio returns can be explained by asset allocation — not by stock-picking or timing. In other words, the decision "how much in equities and how much in bonds" is more important than "which specific equities."
The lifecycle of allocation: from aggressive to conservative
The classic approach says: hold more equities in youth, because time compensates for volatility. As retirement approaches, reduce the equity share and increase stabilisers. The simplified rule "110 minus age = % in equities" is a guideline — modern calculations work with longer horizons and higher individual risk tolerance.
- Age 20–35: 80–100% equities, minimal bonds.
- Age 35–50: 70–80% equities, 20–30% bonds/other.
- Age 50–65: 50–70% equities, remainder bonds and cash.
- Age 65+: depends on the overall situation — there is no need to make everything conservative.
The role of bonds in a portfolio
Bonds reduce portfolio volatility and have historically served as a counterweight during equity declines. In a higher interest rate environment they also offer attractive direct returns. Portfolio risk can be managed precisely through their share.
Cash: not just idle money
Cash (or money-market funds) in a portfolio serves three purposes: liquidity for unexpected expenses, a source for regular withdrawals in the retirement phase, and a psychological cushion that prevents you from panic-selling equities in a downturn. A small cash allocation can paradoxically improve overall portfolio behaviour by reducing emotional pressure.
FAQ
What equity allocation is right?
It depends on age, horizon, income, and psychological resilience to volatility. In general a younger investor can hold a higher equity share. The guideline "110 minus age = % in equities" is a starting point, not a dogma.
Why rebalance the portfolio?
Because equities after a strong run-up constitute a higher share than you originally planned — the portfolio is riskier than your profile warrants. Rebalancing restores the allocation to the target and simultaneously automatically sells the more expensive and buys the cheaper assets.
What is the role of cash in a portfolio?
Cash serves three functions: it provides liquidity for expenses, serves as a source for withdrawals in the retirement phase, and psychologically prevents panic during an equity downturn. Even a small cash allocation can improve investor behaviour in crisis periods.