I used to believe that investing was all about picking the winnings stocks, locking in a great return, rinse and repeat. And I don’t think I’m alone in that.

Stock picking intuitively aligns with the way many people imagine investing works. While it might feel easy to blame the glamour of Scorsese’s Wolf of Wall St, most financial commentary also focuses on individual companies and market personalities. It’s certainly more entertaining to read about what Elon Musk has done this week than to dive into the merits of Modern Portfolio Theory.

In reality, the most important investment decision you’ll ever make probably won’t be that speculative small cap punt or the hot stock tip someone at the bar was talking about. It is far more fundamental than that.

It’s your asset allocation that is the single biggest driver of long-term returns, and therefore your investment success. One of the most cited pieces in modern investing is a study by Brinson, Singer, and Beebower that estimates asset allocation explains 94% of a portfolio’s return variability over time.

At its core, asset allocation simply refers to the mix of growth and defensive assets in your portfolio. This matters for several reasons. Your mix will dictate not only long-term returns but also is how you align your investment strategy to your goals and manage risk appropriately. If you need a detailed primer on asset allocation before diving into this article, Mark lays it out in this module.

Why do we care about asset allocation?

If investors could look into a crystal ball and be told which asset class was going to outperform each year, asset allocation decisions would be easy. But this is far from reality. There is a degree of randomness inherent in determining which assets perform best on a short-term basis. The chart below demonstrates how difficult it is to consistently pick winners and losers. Allocating capital across a range of asset classes helps investors avoid anchoring their portfolio to a single narrative.

Annual returns for selected asset classes ranked in order of performance in each year

Source: Vanguard Asset Class Tool.

But most retail investors don’t wake up thinking about standard deviations or correlation metrics. They think about retiring comfortably, maybe buying a home or generating reliable income. The primary reason we care about asset allocation is because it’s the mechanism that turns our goals into an actual investment strategy.

For example, a long-term goal e.g. a comfortable retirement with decades to run, means an investor may allocate higher exposure to growth assets. On the other hand, if an investor is looking to purchase a home in the next three years, they may favour a larger allocation to defensive assets to manage risk and achieve this goal.

The subtle differences

Many casual investors demonstrate lower levels of engagement with their asset allocations, especially when it comes to super. For example, AustralianSuper currently has over 90% of members in the balanced option, which targets a 75/25 split between growth and defensive assets. Given the average age of an AustralianSuper member is around 42, one could argue that a significant portion of investors may be positioned more conservatively than their time horizon requires.

This matters because even small differences in allocation can compound into surprisingly large gaps over time. No allocation is inherently ‘wrong’ but it may not be optimal for every investor and the cost of being misaligned can accumulate over decades.

Take the below scenario:

James and John are both 25 years old and start with $20,000 in their account. They both contribute $10,000 per year for the next 30 years. James holds a 70/30 split of growth to defensive assets, which we can reasonably expect to return around 6.3% per year over the long-term (Morningstar assumptions). John takes a more aggressive approach with a 90/10 split which should deliver about 7% annually (nominal).

Stretched over the 30-year investment horizon, James finishes with roughly $960k, while John ends up closer to $1.1 million. The nearly $150k that separates them comes down to the level of weighting to growth assets that have historically derived higher returns.

But that extra return doesn’t come for free. John’s path to $1.1 million would have been noticeably bumpier. A 90/10 portfolio would carry meaningfully higher volatility, deeper drawdowns and longer recovery periods. This trade-off is at the heart of asset allocation decisions.

The key point is that your allocation should be an intentional decision that reflects your goals, risk capacity and ability to withstand short-term fluctuations. Most investors will need some level of equity allocation to achieve their long-term goals, but determining the ‘right’ level will be highly personal.

The part investors often miss

There is no perfect formula to determine your asset allocation. Traditional frameworks can provide useful guidance, but they can’t fully capture the personal nature of the decision.

An often overlooked reality is that market dynamics are constantly shifting. The risk profile of asset classes and the correlations between them are not static. But that doesn’t mean investors should attempt to time the market. Instead, it highlights the importance of understanding how the landscape has evolved.

The Callan Institute illustrates this point well. Their research suggests that investors are required to take on more than twice the risk they did 30 years ago to achieve a nominal 7% expected return in the coming decade.

Callan Institute 7% expected returns over past 30 years

Source: The Callan Institute. 2025.

Although, the report notes that the mid-90s were uniquely characterised by not only higher fixed income yields but also higher inflation. To adjust for this, researchers looked at what it would take to earn a 5% real return instead. The figure below shows that the conclusion remains similar.

Callan Institute 5% real returns over past 30 years

Source: The Callan Institute. 2025.

Market dynamics don’t just change over the long-term either. The environment has shifted even in the last few years. Achieving a 7% expected return is now far more feasible than it was in 2022. Back then, an investor would have needed to allocate ~96% of their portfolio to growth assets to reach 7%. In 2025, Callan believes over a third of a portfolio can sit in fixed income whilst still maintaining the same expected return.

The broader takeaway here is that the mix of assets required to meet return objectives evolves over time. Investors today face an increasingly complex landscape. It’s difficult to set an asset allocation and expect it to remain appropriate in the long-term.

Our guidance

There is plenty of asset allocation guidance out there provided by funds and independent firms. Unsurprisingly, industry opinion on the optimal mix is somewhat varied. Below is an example of Morningstar’s risk profile definitions and subsequent strategic asset allocations.

  • Conservative: This suits investors with a minimum three-year timeframe who are targeting a portfolio invested predominantly in defensive assets, with a small allocation to growth assets. It also suits investors seeking to generate more stable but lower returns. A smaller risk of capital loss can be expected compared to profiles with higher growth assets, although negative returns remain possible in certain market conditions. This risk profile carries exposure to defensive assets (cash and fixed interest) of 85%.
  • Moderate: This suits investors with a minimum timeframe of three years who are targeting a diversified portfolio of defensive and growth asset classes, with an emphasis on defensive assets. It also suits investors who are seeking to generate more stable returns and a modest amount of growth with some risk of capital loss and volatility. This risk profile carries exposure to defensive assets (cash and fixed interest) of 70%.
  • Balanced: This suits investors with a minimum timeframe of five years who are targeting balanced returns to meet their medium to long-term goals and are prepared to accept the potential for periods of capital loss to achieve this objective. This risk profile carries 50% exposure to growth (shares, listed property and infrastructure) and a 50% exposure to defensive (cash and fixed interest) assets,
  • Growth: This suits investors with a minimum seven-year timeframe who are targeting a diversified portfolio of growth and defensive assets, with an emphasis on growth assets to meet their long-term goals. Investors are prepared to accept the potential for fluctuations in returns and periods of capital loss. Some exposure to defensive assets is still desired, but the primary concern is a higher potential return, hence the 70% exposure to growth assets (shares, listed property and infrastructure).
  • Aggressive: This suits investors with a minimum nine year timeframe who are targeting a portfolio of predominantly growth assets, with a small portion of defensive asset classes. Investors are willing to accept higher levels of investment value volatility and potential for periods of capital loss in return for higher potential investment performance. The 90% exposure to growth assets (assets (shares, listed property and infrastructure) means that capital stability is not a consideration.
Morningstar SAA Australia

Source: Morningstar Investment Management. April 2024.

Ultimately, the only ‘correct’ allocation is one that aligns with your return objectives, risk tolerance and ability to stay the course.

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