asset-allocation

Diversification proved that blending assets whose returns don't move together shrinks your range of outcomes for free. Asset allocation is the practical sequel: it picks the proportions. The core tool is the risk/return trade-off curve (the efficient frontier in miniature) traced by sweeping the stock/bond split from 0% to 100%. Two facts make it the most useful picture in personal investing. First, the portfolio's expected return is the plain weighted average of its parts, but its risk is LESS than the weighted average — by an amount that grows as the two assets decouple. Second, and counter-intuitively, the curve bows leftward into a hook near the all-bonds end: because stocks and bonds don't move in lockstep, adding a modest slice of stocks to an all-bond portfolio lowers its risk while raising its return. That means 'all bonds' is not the minimum-risk portfolio — a blend is. The bottom of the hook is the minimum-variance mix, the calmest portfolio you can build from the two. Past it, every extra slice of stocks buys return at a steepening cost in volatility, which is exactly the trade-off a long time horizon lets you make. The durable lessons: choose a mix, not a single asset; the safest portfolio holds some of the risky asset; and slide toward stocks when your horizon is long and toward bonds as you'll need the money sooner — the glide path.