Allocation is the decision that dominates almost everything else. Which specific fund tracks the index matters far less than whether you hold 80% equities or 40%, because the asset class drives both the return you can expect and the size of the falls you have to sit through.
The trade-off is not risk versus return in the abstract; it is which risk you would rather carry. A heavy equity allocation carries the risk of a deep drawdown at a bad moment. A heavy bond and cash allocation carries the risk that your money loses purchasing power slowly and reliably over a long retirement. Both can end a plan.
Allocation also drifts. A 60/40 portfolio left alone through a strong equity decade becomes something closer to 75/25, at which point you are carrying more risk than you agreed to. That drift is what rebalancing exists to correct.
Because allocation dominates the outcome distribution, it is the input worth testing hardest. Running the same plan at several allocations against identical markets shows the trade in the only terms that matter: how much the range of outcomes widens.
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See also
- Rebalancing — Periodically selling what has grown and buying what has lagged to return a portfolio to its target asset allocation.
- Glide path — A predetermined schedule that shifts a portfolio from higher-risk to lower-risk assets as a target date approaches — the mechanism inside target-date funds.
- Drawdown — The percentage fall from a portfolio’s previous peak to its lowest subsequent point. Maximum drawdown is the largest such fall over a period.