What it means
The mix matters more than the individual picks. Over long periods the split between shares, bonds, property and cash explains most of the variation in a portfolio's returns, far more than the choice of one company's shares over another's.
There is usually a difference between the target mix and the actual mix. Markets move at different speeds, so a portfolio set at 60% shares can drift to 68% after a strong year, quietly carrying more risk than its owner signed up for.
Rebalancing brings the actual mix back to the target by selling some of what has grown and buying what has lagged. It feels wrong every time, which is precisely why many investors set a rule, such as rebalancing annually or whenever a class drifts more than five percentage points.
Choosing the right mix comes down to three questions: how long before the money is needed, how much income it must produce along the way, and how large a fall the owner can tolerate without selling at the bottom. A 25 year old and a retiree drawing income should not hold the same mix.
Businesses face the same question with their own balance sheets. A treasurer decides how much sits in instant access cash, short-term deposits and longer instruments, and getting that mix wrong is how a solvent company still runs out of usable money.
In practice
Real-world examples.
Example
A 30 year old saving into a pension holds 85% in global shares and 15% in bonds. With more than 30 years before the money is touched, she treats a 25% fall as a buying opportunity rather than a problem.
Example
A retiree with $600,000 wants income and holds 35% shares, 50% bonds and 15% cash. That produces $210,000 of shares yielding 3%, or $6,300, $300,000 of bonds yielding 4.5%, or $13,500, and $90,000 of cash yielding 3%, or $2,700, giving $22,500 a year.
Example
A software company treasurer splits a $5,000,000 reserve into instant access cash for payroll, 90 day deposits for quarterly tax bills and a small allocation to longer notice accounts. The mix is chosen by when the money is needed, not by which account pays most.
Formula
Calculation
Weight of an asset class = value of that class / total portfolio value
Rebalancing trade = current value of the class - (target weight x total portfolio value)
A portfolio of $800,000 is set at 60% shares, 30% bonds and 10% cash, which is $480,000, $240,000 and $80,000.
Over the year the shares gain 20% to $576,000, the bonds gain 3% to $247,200 and the cash gains 2% to $81,600. The portfolio is now worth $576,000 + $247,200 + $81,600 = $904,800, and shares have drifted to $576,000 / $904,800 = 63.7% of the total.
Rebalancing to target means shares should hold $904,800 x 0.60 = $542,880, so $576,000 - $542,880 = $33,120 is sold. Bonds should hold $904,800 x 0.30 = $271,440, requiring a purchase of $24,240, and cash should hold $904,800 x 0.10 = $90,480, requiring $8,880. The two purchases total $24,240 + $8,880 = $33,120, exactly the amount raised from the share sale.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. The Vale family, an invented case, held a $2,000,000 portfolio of which $1,400,000, or 70%, was shares in the single employer where two family members worked, with the rest in a mixed fund.
Their adviser pointed out that the mix carried two risks in the same place: if the employer struggled, both the jobs and the savings would suffer together. The family had grown comfortable with the position because it had performed well for years.
The employer's share price then fell 45%, wiping $630,000 off the holding and cutting the portfolio to $1,370,000, a fall of 31.5% while broad markets were roughly flat. The fictional family rebuilt around a 55% shares, 35% bonds and 10% cash mix, accepting a lower expected return in exchange for never again having their income and their savings depend on one company.
Watch out
Common mistakes.
- Setting a target mix once and never checking it again, so market movements quietly turn a moderate portfolio into an aggressive one.
- Counting several funds as diversification when they all hold the same large companies, which leaves the real mix far more concentrated than the fund names suggest.
- Choosing a mix based on how markets feel right now rather than on when the money will actually be needed.
Questions
People also ask.
What is the difference between asset mix and asset allocation?
They describe the same idea, with allocation more often used for the target policy and mix more often used for the holdings as they stand today.
How often should a portfolio be rebalanced?
Once a year is enough for most investors, or whenever a class drifts more than about five percentage points from its target.
Should property and pensions be counted in the mix?
Yes, any meaningful asset should be included, because ignoring a large property or pension holding gives a misleading picture of the real exposure.
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