Figuring out your asset allocation sounds like one of those investing concepts that should require a spreadsheet, a financial advisor, and maybe a PhD. It doesn't.

In fact, I would argue that asset allocation is simultaneously one of the most important investing decisions you will make and one of the easiest places to get completely lost in the weeds. Should you own 90% stocks and 10% bonds? 80/20? 70/30? What about international stocks? Small cap value? Real estate? Should your bond allocation equal your age? Your age minus 10? And what happens when the market crashes?

Before long, a physician who just wanted to invest their 401(k) is 17 browser tabs deep and more confused than when they started. And I've talked to tons of doctors who have huge amounts just sitting in a money market fund because they still can't quite find the asset allocation that is just right for them. Unfortunately, in this process they've actually lost money due to inflation and missed out on advancing their path towards financial freedom as compound interest is not working for them.

So let's simplify this. Because when it comes to asset allocation, good is better than perfect.

What Is Asset Allocation?

Your asset allocation is simply how you divide your investment portfolio among different types of investments. For most investors, the biggest decision is how much to invest in stocks versus bonds. You can certainly add real estate and other investments. I do. But you don't need to start there.

Stocks are generally the growth engine of your portfolio. They carry more volatility and risk, but historically have offered greater potential long-term returns. Bonds are generally the stabilizer. They tend to offer lower expected returns, but also less volatility.

I like to think about bonds as the ballast in a ship. Ballast doesn't make the ship faster. In fact, you could argue it slows the ship down. But it helps keep the ship upright when the water gets rough. Your asset allocation is essentially deciding how much growth potential and how much stability you want to build into your portfolio.

And that makes it a pretty important decision.

But There Is No Perfect Asset Allocation

This is where people get hung up. They want to know the right asset allocation.

Unfortunately, I can't give you that answer because there isn't one. There are certainly some asset allocations that make more sense than others. But there is no single mathematically perfect allocation that applies to everyone.

An investor with 30 years until retirement is in a very different situation than someone retiring next year. Someone who watches the stock market drop 20% and barely notices is different from someone who loses sleep after a 5% decline. And someone with a very large portfolio relative to their spending needs may be able to take more risk than someone whose financial plan depends on squeezing every last dollar out of their portfolio.

So your goal isn't to find the perfect asset allocation. Your goal is to find a reasonable asset allocation that fits your financial plan and, most importantly, that you can actually stick with.

A good plan that you follow beats a theoretically perfect plan that you abandon the first time the market gets scary.

Start With Stocks and Bonds

When you're getting started, I recommend keeping things really simple. Figure out your stock and bond allocation first.

One rule of thumb that I've used is to take your age, round it to the nearest 10, and use that as a rough starting point for your bond allocation. I've also used a slightly more aggressive variation of age rounded to the nearest 10 minus 10.

So a 34-year-old investor might start thinking somewhere around 20% to 30% bonds, with the remaining 70% to 80% in stocks.

Is that scientifically perfect? Nope. It's a starting point. And that's exactly what we need.

From there, you can adjust based on two factors that matter much more than any rule of thumb: your investing timeline and your ability to handle risk.

Your Timeline Matters More Than Your Age

Age is useful because it loosely approximates something much more important: when you need the money.

Imagine two 45-year-old physicians. One wants to reach financial independence at 50 and plans to start drawing significantly from their portfolio soon after. The other loves practicing medicine, expects to work until 70, has plenty of cash reserves, and doesn't anticipate touching their retirement portfolio for decades.

Should they automatically have the same asset allocation because they are the same age? Of course not.

The second physician has a much longer investing timeline. That gives them more time to ride out the inevitable ups and downs of the stock market. The first physician has a different priority. Portfolio preservation is becoming increasingly important because they will need the money sooner and have less time to recover from a major downturn.

This same concept applies outside retirement. Money you need next year for a house down payment shouldn't be invested like money you won't need for 30 years. The stock market may offer higher expected returns over long periods of time, but it does not care that your closing date happens to be six months after a bear market begins.

As the date when you need your money approaches, protecting that money becomes increasingly important. Early in your investing journey, you are generally focused more on growth. As you get closer to needing the money, stability becomes more important. Your asset allocation should reflect that.

Risk Tolerance Is More Complicated Than You Think

The second big factor is risk tolerance. And this one is tricky because everyone has a high risk tolerance when the stock market is going up.

It's much harder to know how you will react when your $1 million portfolio suddenly becomes $750,000 and seemingly every headline says things are going to get worse. It's easy to fill out a questionnaire during a bull market and say that you would happily buy more stocks after a major decline. Living through that decline is something else entirely.

This is why I've started thinking less about “risk tolerance” and more about your investing margin for error.

Instead of simply asking, “How much risk can I tolerate?” ask what happens if things don't go according to plan. How much volatility can your financial plan handle? How much can your portfolio fall without changing your lifestyle or your ability to reach your goals? And, just as importantly, how much can it fall before you panic and change your investing strategy?

That last question matters because behavior matters.

A 100% stock portfolio may have a higher expected long-term return than an 80/20 portfolio. But that doesn't help you if a bear market causes you to sell everything at the bottom. In that situation, the supposedly more conservative portfolio may actually produce the better real-world result simply because you stick with it.

Your asset allocation needs to be aggressive enough to help you reach your goals while being conservative enough that you can stay invested when markets inevitably get ugly.

Now Keep the Investments Simple

Once you decide on your broad allocation, you need investments to fill those buckets. Again, don't overcomplicate this.

If you decide on 80% stocks and 20% bonds, you could build a perfectly reasonable portfolio using a broadly diversified total stock market index fund and a total bond market index fund. That's it.

You can certainly divide your stock allocation between U.S. and international stocks. You can add real estate. Or you can tilt toward other asset classes if you understand why you are doing it.

But complexity is optional. A simple portfolio of low cost, broadly diversified index funds is better than an elaborate portfolio that leaves you constantly tinkering with it. My own portfolio is largely based on the two fund for life model.

Remember, investing is one area where doing more does not necessarily lead to better results.

Then Do the Hard Part: Nothing

Once you create your asset allocation and invest accordingly, something interesting happens. Your job becomes pretty boring.

That's a good thing.

The market will go up. It will go down. Stocks will outperform bonds for a while and everyone will wonder why anyone owns bonds. Then the environment will change and suddenly bonds will look attractive again. International stocks will have their moment. U.S. stocks will have theirs. Whatever has recently done best will inevitably start looking like the investment you should own more of.

Ignore it.

Changing your asset allocation based on what has recently performed well is just another form of market timing (which simply just does not work). Plus, if you are tinkering with investments in taxable accounts, you are just going to accrue more fees and taxes, Instead, follow your plan and periodically rebalance back to the allocation you chose when you were thinking rationally rather than reacting emotionally.

When Should You Rebalance?

Rebalancing simply means bringing your portfolio back toward your target asset allocation.

Let's say you decide on an 80% stock and 20% bond portfolio. Stocks have a great run, and eventually your portfolio becomes 85% stocks and 15% bonds. Your portfolio is now more aggressive than you intended. Rebalancing means moving it back toward 80/20.

There are two reasonable ways to decide when to do this

The first is calendar-based rebalancing. Pick an interval, such as once a year, and check your portfolio at that time. If your allocation has drifted meaningfully away from your targets, rebalance it. I like this approach because it is simple and removes emotion from the decision. Put it on your calendar, check once, make any necessary adjustments, and move on with your life.

The second approach is threshold-based rebalancing. Instead of waiting for a particular date, you rebalance when an asset class moves a predetermined amount away from its target. For example, you might decide that you will rebalance whenever an allocation moves 5 percentage points away from its target.

You can also combine the two approaches

Check your portfolio once or twice each year and rebalance only if something has moved outside of your predetermined range.

There is no prize for rebalancing with perfect precision. In fact, checking constantly can create the temptation to tinker unnecessarily. The purpose of rebalancing isn't to keep your portfolio mathematically perfect every day. It is to keep the level of risk in your portfolio reasonably close to the level of risk you intentionally chose.

And you don't always need to sell investments to rebalance

If you're still accumulating assets, which many physicians are for much of their careers, you can often direct new contributions toward whichever asset class is underweight. If stocks fall and your bond percentage becomes too high, for example, new contributions can be directed toward stocks until the portfolio gets closer to its target.

This can also be useful in taxable accounts because selling appreciated investments may create capital gains taxes. Dividends, distributions, and new contributions can all be used to help bring your portfolio back into balance without creating unnecessary taxable events.

The beautiful part of rebalancing is that it forces you to do something that feels psychologically uncomfortable but makes investing sense. You sell, or stop buying, some of what has done relatively well and buy more of what has done relatively poorly. In other words, you're systematically buying low and selling high rather than chasing performance.

Then you go back to doing nothing.

Your Asset Allocation Will Change

There is one final point worth emphasizing. Your asset allocation is not carved into stone.

We all know that life changes. Your investing timeline changes. Your goals change. And your financial situation changes. And your actual experience living through market volatility may teach you that your risk tolerance is different than you thought.

A physician approaching retirement may gradually increase their bond allocation because preserving their accumulated wealth has become more important. Someone who reaches financial independence earlier than expected may realize they no longer need to take as much investment risk. Conversely, someone with a very long time horizon and a large margin for error may be comfortable maintaining a more aggressive allocation.

So your allocation should evolve as your financial plan evolves. But there is a huge difference between intentionally changing your asset allocation because your financial plan changed and emotionally changing it because CNBC scared you.

The first is financial planning. The second is market timing. Know the difference.

Good Beats Perfect

If you currently have money sitting on the sidelines because you're trying to determine whether your ideal portfolio is 80/20 or 75/25, you're focusing on the wrong thing.

Pick a reasonable allocation. Use broadly diversified, low cost investments. Invest consistently. Rebalance periodically. Then give compound interest the most important ingredient it needs: time.

You can optimize as you learn more. You can adjust your allocation as your circumstances change. And you can add complexity later if there is a good reason to do so. And you can refine your plan as you gain the most valuable investing education of all, which is actually living through different market cycles.

But don't let the pursuit of the perfect asset allocation stop you from creating a good one today.

Because the biggest investing mistake usually isn't choosing 80/20 when 70/30 would have been slightly better. It's spending so much time trying to create the perfect investing plan that you never actually start investing.

What do you think? What is your asset allocation? How did you determine it? How do you know when to rebalance? Do you find yourself chasing “perfect” over maintaining “good”? Let me know in the comments below!