Asset Allocation and Portfolio Construction
Allocation is the decision; construction is the execution
Strategic asset allocation sets long-run target weights matched to goals, time horizon, and risk tolerance; tactical tilts deviate modestly to exploit valuations. Modern portfolio theory supplies the vocabulary: expected return, standard deviation, correlation, and the efficient frontier - the set of portfolios offering the highest expected return for each level of risk. Diversification reduces portfolio volatility when assets are less than perfectly correlated; a correlation of +1.0 provides no benefit.
Construction tools include core-and-satellite structures, style boxes, rebalancing bands, and the recognition that rebalancing is a disciplined, contrarian risk-control activity rather than a return forecast. Life-cycle and target-date funds de-risk along a glide path. Bucket approaches fund near-term spending with cash and short bonds so long-term assets can stay invested.
Traps. (1) Diversification cannot remove systematic (market) risk - only unsystematic risk. (2) Allocation should follow goals and capacity, not age alone, though "110 minus age" is a common starting heuristic for equity weight. (3) Rebalancing is not market timing; it enforces sell-high/buy-low. (4) Holding many similar funds is diworsification, not diversification.
Rule of thumb. Rebalance when a sleeve drifts 5 percentage points absolute or 20% relative from target, or on a calendar schedule. Because correlations rise in crises, stress-test the plan rather than assume historical relationships hold.