The strength of asset allocation

min read

May 15, 2026

Authors:
Hannah Commoss Institutional Portfolio Manager, Fidelity Investments
Mia Kafoury Institutional Portfolio Manager, Fidelity Investments

When it comes to building model portfolios, there are benefits to taking a strategic view.

A feature article from our U.S. partners

Strategic approaches to asset allocation apply modern portfolio theory and long-term return projections to determine allocations within a portfolio, seeking to allocate assets along the efficient frontier.
Greater diversification can lead to higher risk-adjusted returns, as shown by movement along the efficient frontier.
Disciplined and regular rebalancing can help improve risk-adjusted returns over time by reducing volatility and mitigating the impact of market drawdowns.
We believe that building portfolios using a strategic asset allocation framework, that also incorporates rebalancing, is an effective way to balance risk and return for a wide range of investors.

Increasing volatility, rising asset class correlations, higher interest rates, and the emergence of alternative investments: There’s no question that the investing landscape of the 2020s presents a different set of challenges than that of previous decades. When it comes to building model portfolios that can meet those challenges, a strategic asset allocation still delivers on its objective of providing attractive risk-adjusted returns over long-term horizons. We believe that defining a strategic asset allocation is the most important decision an investor makes, accounting for a majority of the variation of portfolio returns.

Strategic asset allocation

Asset allocation is an investment strategy that seeks to combine various asset classes such as domestic and foreign stocks, bonds, and cash with the goal of matching portfolio-level risk (longer-term return variability) with the stated risk tolerance of a given investor.

The goal of strategic asset allocation is to arrange asset classes so that the resulting portfolio volatility is lower than the sum of its individual components. Because different asset classes tend to react differently to changing market and economic conditions, a well-designed allocation can help to manage risk without impairing expected return.

Strategic asset allocation seeks to maximize the benefits of diversification by arranging asset classes as efficiently as possible, often through the use

of mean variance-based optimization.¹ Within this context, efficiency is defined as the highest possible return for a given level of risk. Positioned along the risk spectrum, each allocation mix defines what has come to be known as the efficient frontier (Exhibit 1).

Over time, many portfolio managers have added additional asset classes, such as emerging-market equities, emerging-market bonds, commodities, currencies, real estate investment trusts, and alternative investments to augment the allocation mix and drive efficiency measures higher. The intent of this evolution has been to move the efficient frontier upward, increasing the amount of potential return at any given point along the risk spectrum. Regardless of the mix of assets, strategic asset allocation starts with risk. It is the first thing that most optimization processes solve for. Due to the relationship between risk and return for each asset class, an expected level of return for the entire portfolio can be estimated based on its risk characteristics. This consideration of risk has important implications for the management of a strategically allocated portfolio.

Exhibit 1: Allocation mixes aligned along the efficient frontier

This chart shows portfolios along the efficient frontier, where higher expected returns are associated with higher levels of risk. As risk increases, allocations shift gradually from short term assets and bonds toward greater exposure to domestic and foreign equities. Asset mixes change progressively with risk tolerance rather than relying on a single asset class.

Short-

term

Conservative

Moderate

with income

Moderate

Balanced

Growth

with income

Growth

Aggressive

growth

Most

aggressive

Average returns

3.29%

5.82%

6.59%

7.26%

7.89%

8.49%

8.97%

9.71%

10.29%

Historical volatility

0.86%

4.55%

6.19%

7.83%

9.54%

11.27%

12.97%

15.62%

18.25%

Rebalancing: A key tenet of strategic asset allocation

If portfolio risk is ultimately a function of a specific mix of assets, then it follows that any deviation from this mix could result in unanticipated changes to the risk profile of the portfolio. Since asset class valuations are in a near-constant state of flux, portfolio risk is seldom static.

Rebalancing is the tool by which asset allocators can keep portfolio risk aligned with an investor’s risk tolerance across different market environments. Methodologies can vary. Calendar-based rebalancing may use monthly, quarterly, semiannual, or any number of time-based periods to realign portfolio weights with target allocations. Other managers may use bandwidth constraints that attempt to keep asset class weights within a specified range. Either way, the goal is to keep portfolio allocations aligned with their target weights.

Beyond its purely mechanical aspects, rebalancing can also introduce additional positive attributes to the portfolio. Often termed “rebalancing gains,” the process of disciplined and regular rebalancing introduces a dollar-cost-averaging effect into a portfolio. As markets move, rebalancing involves selling off assets that have moved up in value and adding to assets that have lagged or declined. This can reduce the average cost of each asset exposed to the rebalancing process. A related benefit can be found in the avoidance of excess concentration in a particular asset class after a major run-up in prices. This prevents the portfolio from being overly exposed to at-risk asset classes at market inflection points (Exhibit 2).

Exhibit 2: Rebalancing a portfolio composed of 60% stocks and 40% bonds back to its target mix on a quarterly basis over the past few decades would have avoided concentration in highly valued assets at market peaks.

How rebalancing affects concentration risk

This chart compares a rebalanced portfolio with a buy and hold approach from the early 1980s to 2025. The rebalanced portfolio keeps equity concentration relatively stable around 55 to 60 percent across market cycles. In contrast, buy and hold equity concentration rises sharply during market peaks, reaching roughly 80 to 90 percent during periods such as the tech bubble and COVID 19, showing how rebalancing can help limit concentration risk over time.

Measuring risk

Since risk is central to the concept of strategic asset allocation, it makes sense to look at more than return alone. Here the evidence is unambiguous. In our analysis, rebalanced portfolios exhibited consistently less risk than buy-and-hold portfolios (Exhibit 3).

Long time periods can cover a multitude of sins, so we looked at rolling three-year periods and what we see is that the annualized standard deviation of monthly returns for the rebalanced portfolio was significantly below that of the buy-and-hold portfolio. The average reduction in volatility over the period was 2.1%.

Exhibit 3: Rebalancing a portfolio made up of 60% stocks and 40% bonds over a recent 40-year period resulted in consistently lower volatility than a portfolio that wasn’t rebalanced back to its target asset mix.

The impact of rebalancing on risk

This chart shows that a quarterly rebalanced 60 percent stock and 40 percent bond portfolio experienced consistently lower volatility than a buy and hold portfolio over the past 40 years. Rolling standard deviation for the rebalanced portfolio generally stays in the high single digits to low teens, while buy and hold volatility rises higher during market stress periods such as the early 2000s and 2020.

Building resilient portfolios

Another key component of strategic allocation is building resilient portfolios that can weather severe market drawdowns. One way to evaluate portfolio resilience return is to look at metrics such as maximum drawdown. Utilizing rolling 5-year max drawdowns, Exhibit 4 shows that the rebalanced portfolio suffered less severe drawdowns throughout the 40-year time horizon, outperforming the buy-and-hold portfolio by 6.8% through the sustained bear market following the dot-com crash of the early 2000s, by 6.1% during the Global Financial Crisis, and by 2.8% during the COVID crash of 2020.

Exhibit 4: Impact of strategic allocation on drawdown severity

Rolling five-year max drawdown, 1986–2025

This chart compares rolling five-year maximum drawdowns for a quarterly rebalanced portfolio and a buy and hold portfolio from 1986 to 2025. During major market stress events such as the Global Financial Crisis, the rebalanced portfolio experienced smaller drawdowns of roughly 30 percent compared with about 40 percent for buy and hold

Conclusion

Our analysis shows that strategic asset allocation is an effective asset allocation approach because it places the management of risk at the heart of this process. We believe identifying an investor’s risk tolerance and constructing a portfolio that attempts to meet that risk tolerance is in an investor’s best interest and offers the best road map for achieving one’s long-term investment goals.

Footnotes

Date first published: April 10, 2026

Endnote

1. Mean-variance optimization is an analysis conducted as part of the portfolio construction process, which determines an allocation that will maximize the expected return of the asset mix after accounting for the risk tolerance of the investor, for the expected variance of the asset mix. Mean-variance optimization is an important tenant of modern portfolio theory.

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