The Bogleheads' Guide to Investing, 2nd Edition

Chapter Eight Asset Allocation: The Cornerstone of Successful Investing

The most fundamental decision of investing is the allocation of your assets: How much should you own in stocks? How much should you own in bonds? How much should you own in cash reserve?”

—Jack Bogle

Your most important portfolio decision can be summed up in just two words: asset allocation. In this chapter we’ll help you design an asset allocation plan based on your goals, time frame, risk tolerance, and personal financial situation. In addition, we look at some of the extensive academic research studies on the topic that have led to remarkably similar conclusions.

It was Sancho Panza, Don Quixote’s sidekick, who observed: “It is the part of a wise man to keep himself today for tomorrow and not to venture all his eggs in one basket.” Asset allocation is the process of dividing our investments among different kinds of asset classes (baskets) to minimize our risk, and also to maximize our return for what the academics call an efficient portfolio.

How do we do this? Well, we begin by asking ourselves two questions: “What investments should we select?” and “What percentage should we allocate to each investment?” The academic community has spent a great deal of time and research trying to answer these two questions. They have given us sophisticated theories that we can use to select our investments and combine them in the most efficient manner to give us maximum return with minimum volatility.

THE EFFICIENT ...