Talks about portfolio asset allocation are often reignited whenever stock market investors are facing uncertainty.
When the Trump administration’s tariff policies sent many stock market indexes into correction territory, discussions arose about how to create portfolios for an uncertain economy. The conversation swung to defensive stocks, shorter-term fixed securities, equal-weight exchange-traded funds (ETFs), international stocks, safe-haven assets such as gold, and cash for purchasing quality assets at a discount.
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However, it remains true that prevention is the best medicine. Therefore, instead of looking around for an escape route when the market is down, it is best to set up a portfolio that can withstand periods of market volatility.
Such a portfolio will best match your risk tolerance and risk capacity and put you in the best position to achieve your financial goals within your time horizon.
What Determines the Best Portfolio Asset Allocation?
Before going any further, it is imperative to mention that there is no one best portfolio asset allocation formula for everybody. Since people’s financial goals, time horizon, risk capacity, risk tolerance and income requirements vary, the asset allocation formula most appropriate for them will differ. But let’s take these factors in turn, and it will soon become obvious how they interweave to create an optimal portfolio.
Financial Goals
There is a close relationship between a financial goal you are pursuing and your time horizon and risk capacity.
For example, suppose your goal is to have enough money in three years to make a down payment on a property. In this case, you have a short time horizon and a low capacity for risk.
Generally, there is a correlation between time horizon and capacity for risk. For example, a short time horizon often means a lower capacity for risk and a longer time horizon means a higher capacity for risk.
Suppose the goal is to retire with a $10 million nest egg in the next 30 years. Here, the time horizon is long, which means a higher capacity for risk.
Time Horizon
Time horizon is the timeframe you expect to remain invested before needing to liquidate your investment to meet the desired financial goal. Time horizon can be short (less than three years), medium (three to 10 years) or long (more than 10 years). It is the major factor in determining risk capacity.
In our examples above, we have a three-year time horizon and a 30-year time horizon.
Risk Capacity
Risk capacity is the amount of risk you should be willing to take on based on your financial goal and time horizon. The idea of risk capacity is important because there is often a risk-return tradeoff in the financial markets.
If your goal requires a high rate of return, then you must be willing to embrace more risk. But more risk means that your investment may be in the red in the short term (volatility is high in the short term). High-risk assets often produce consistent high returns over a long period.
Thus, if your time horizon cannot endure the time it takes for high-risk assets to produce high returns, you may need to settle for low-risk and low-return assets.
In the examples above, the three-year goal with a lower capacity for risk will require low-risk and low-return assets, while the 30-year goal with a higher capacity for risk will require high-risk and high-return assets.
Risk Tolerance
Risk capacity is the amount of risk you should be willing to take on, while risk tolerance is the amount of risk you are comfortable taking on. The aim is to achieve a risk alignment where risk tolerance equals risk capacity. A desire for risk alignment is one reason why investors with a long time horizon don’t just put 100% of their money in high-risk, high-return assets.
While their risk capacity can support such an allocation (at least for a while), their risk tolerance may not. Thus, they may need to add some low-risk, low-return assets to reduce their risk exposure.
Similarly, risk tolerance can manifest in how well an investor can stomach watching their portfolio drop dramatically. Those who invest only in high-risk, high-return assets must deal with such situations occasionally. If you can’t bear it, reducing your portfolio risk by diversifying into low-risk, low-return assets is a useful strategy.
Income Requirements
When you need to earn consistent (quarterly, yearly or monthly) income from your investments, then you must factor that into your asset allocation decisions. For example, investors nearing retirement need to increase their allocation to income-generating assets like bonds and dividend-paying stocks to meet their income needs in retirement.
There are also investors building wealth (as their primary goal), but who desire to earn consistent income from their portfolio. Some investors like consistent income to benefit from compounding.
Since most income-generating assets are low-risk and low-return, it means an investor with a long time horizon and high risk capacity can still allocate money to low-risk, low-return assets for the sake of income.
Best Portfolio Asset Allocation for Different Investors
Given all we have discussed, we can roughly divide investors into three categories:
— Conservative. Investors can be conservative because they have a combination of a short time horizon, lower risk capacity, lower risk tolerance and high income needs. However, it is not impossible to find investors who have a long time horizon and high risk capacity but choose to be conservative due to low risk tolerance or high income needs.
— Moderate. Moderate investors can have a combination of a medium time horizon, risk capacity, risk tolerance and income needs. They may also be investors with a long time horizon and high risk capacity, but low risk tolerance and a medium-to-high need for income.
— Aggressive. These are investors with a long time horizon, high risk capacity, high risk tolerance and low income needs. Some investors with a medium time horizon and risk capacity can also be aggressive because of their high risk tolerance and low income needs.
Best Portfolio Asset Allocation Formula for Conservative Investors
For conservative investors, low-risk and low-return assets dominate. We have identified two types of conservative investors above, so let’s consider how asset allocation can work for them.
First is the conservative investor with a combination of a short time horizon, low risk capacity, low risk tolerance and high income needs. Below is a sample portfolio for such an investor:
— Fixed-income securities: 80%
— Cash: 10%
— High-risk, high-return assets: 10%
Second is the conservative investor with a long time horizon and risk capacity, but low risk tolerance and high income needs. Such an investor will buy more high-risk, high-return assets than in the first example. A sample portfolio can look like this:
— Fixed-income securities: 60%
— Cash: 20%
— High-risk, high-return assets: 20%
Best Portfolio Asset Allocation Formula for Moderate Investors
First is the moderate investor with a combination of a medium time horizon, risk capacity, risk tolerance and income needs. Below is a typical portfolio:
— High-risk, high-return assets: 50%
— Fixed-income securities: 40%
— Cash: 10%
If the moderate investor has a long time horizon and high risk capacity but a medium risk tolerance and medium-to-high income needs, a typical portfolio can look like this:
— High-risk, high-return assets: 60%
— Fixed-income securities: 30%
— Cash: 10%
Best Portfolio Asset Allocation Formula for Aggressive Investors
Below is a typical portfolio for an aggressive investor with a long time horizon, high risk capacity, high risk tolerance and low income needs:
— High-risk, high-return assets: 80%
— Fixed-income securities: 10%
— Cash: 10%
For investors with a moderate time horizon and risk capacity but a high risk tolerance and low income needs, this portfolio can look like the one below:
— High-risk, high-return assets: 70%
— Fixed-income securities: 20%
— Cash: 10%
[SEE: 9 Best Stocks for a Starter Stock Portfolio.]
Creating the Best Portfolio Asset Allocation for You
Tweak the Sample Portfolio That Best Fits Your Situation
The sample portfolios above provide a general guideline that you still need to adapt to your situation. For example, as an aggressive investor, you can choose an 80%/15%/5% portfolio instead of the 80%/10%/10% portfolio above.
Decide Which Assets to Include Under Each Category
For most investors, high-risk, high-return assets are just stocks. However, others may be more willing to add cryptocurrencies, commodities, derivatives and even private investments.
Bitcoin (BTC) is an example of the former, with its risk-adjusted returns beating those of stocks in recent years. Gold is an example of the latter; its performance so far in 2025 has reinforced its value as a safe haven.
Similar decisions must be made when it comes to fixed-income securities. Some will only buy bonds, while others will also consider Treasury bills, Treasury notes, certificates of deposit and commercial paper, among other investments.
Decide on Allocation Percentages
Next, you need to decide the allocation formula as you go from broad to narrow categories. For example, if you have chosen to allocate 60% of your investment funds to high-return and high-risk assets, you need to decide how to allocate that 60% among local stocks, international stocks and other asset classes (cryptocurrencies, commodities, derivatives and private investments).
Choose Between Funds and Individual Assets
Similarly, you need to decide if you prefer to invest in individual assets or funds (mutual funds, ETFs or index funds). If the latter, you will also need to choose specific funds based on factors like historical performance, holdings, risk profile and expense ratio, among other criteria.
Putting It All Together
Let’s consider a generic example that reflects all these considerations. Suppose Amanda is an aggressive investor who prefers exchange-traded funds and loves to achieve broad diversification for return amplification and risk management reasons.
Below is a sample portfolio that Amanda can construct:
— S&P 500 ETF: 40%
— Total market international stocks ETF: 20%
— Bitcoin ETF: 5%
— Gold ETF: 5%
— Private equity: 10%
— Total bond market ETF: 5%
— Short-term Treasury ETF: 5%
— Cash: 10%
As you go into more granular details, like we did for Amanda, you will need a professional who can help you make specific decisions based on their knowledge of the financial markets and your specific situation. In other words, personalizing the best portfolio asset allocation requires that you speak to a financial advisor. They can help you create an efficient, well-designed portfolio to achieve your financial goals.
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What’s the Best Portfolio Asset Allocation? originally appeared on usnews.com
