Choosing Your Strategic Asset Allocation — Part 1: What Are Your Options?

Last week, you defined your destination — the return you need, how long you have, and how much pain you’re willing to endure along the way. Now comes one of the most important portfolio decisions you’ll ever make: choosing your strategic asset allocation.

Your strategic asset allocation (SAA) is the long-term mix of stocks, bonds, and other assets you’ll hold. It’s the foundation of your portfolio — the blend you’ll live with through both the good years and the ugly ones.

It sounds almost too simple to matter. In reality, few decisions have a bigger impact on your investing experience. Most investors spend their time worrying about stock picks and market forecasts, when the far more important question is how much they own of each asset class in the first place. Research shows that more than 90% of how a portfolio swings around over time traces back to its asset mix — not stock picking, not timing (Brinson, Hood & Beebower, 1986).

The framework we use at InvestLab reflects this idea. Strategic asset allocation sits at the base of the pyramid because it carries most of the portfolio’s weight. Tactical views and satellite positions may add value around the edges, but they’re unlikely to compensate for a poorly designed core.

Strategic asset allocation is the base of the pyramid — the widest tier, because it carries most of your risk and return. Get it right first; the tactical and satellite layers are only refinements on top.

That’s why this lesson comes first. Before deciding what you think about today’s market, it’s worth deciding what kind of portfolio you’re trying to build. So how do you decide what your keel should look like?

That’s where the work you did in Week 1 comes in. Your return objective, investment horizon and tolerance for losses act as constraints. They don’t tell you exactly what portfolio to own, but they help narrow the field. A good SAA has one job: to maximise the probability that you’ll achieve your objectives — put differently, to minimise the risk of failure.

That’s why there is no universally “best” portfolio. The right one for a 25-year-old saving for retirement may be entirely wrong for someone buying a house in three years. Success depends on the investor, their goals, and the constraints they face.

Option 1: How about 100% equities?

For many investors, this is the obvious starting point. Stocks have historically delivered higher returns than almost every other liquid asset class. Over long periods they’ve rewarded investors for taking risk, and for many people a globally diversified equity portfolio is a perfectly sensible solution.

If my only objective were to maximise expected returns, and I had a very (very) long horizon, the discussion might end here. But those aren’t my objectives. My goal is to maximise the probability of achieving them — roughly 7–10% a year over 30 years, while avoiding losses larger than 50% and keeping the odds of very poor long-term outcomes acceptably low. Against that yardstick, a 100% equity portfolio struggles, for two reasons.

The first issue: drawdowns

Equities are wonderful wealth-building assets, but they can be brutal companions. Large drawdowns aren’t rare accidents — they’re part of the package. The Nasdaq lost almost 80% after the dot-com bubble and took roughly 15 years to recover. Japanese equities took more than three decades to reclaim their previous peak. After the 1929 crash, US investors waited around 25 years to get back to breakeven in real terms. These weren’t obscure or speculative markets — they were among the world’s largest and most successful equity markets right before the declines.

Drawdowns from prior peak for four world-leading equity markets, plotted against years since the peak. Losses of 80%+ that took decades to recover aren’t tail freaks — they happened to the biggest markets of their day.

For me, that’s a problem. To reach my long-term goals I need a portfolio I can realistically hold through difficult periods. Losing 80% of my wealth, or waiting decades to break even, falls outside that range — which is why my IPS sets a maximum acceptable drawdown of 50%.

Could global diversification solve the problem? It certainly helps — owning thousands of companies across dozens of countries is far safer than concentrating in a single market. But it doesn’t eliminate equity risk. Global stocks still lost roughly 55% during the Global Financial Crisis, and there’s no reason future drawdowns couldn’t be larger or longer.

To get a sense of the range of outcomes, I used the InvestLab IPS simulator. Feeding in assumptions similar to a global equity portfolio (7% return, 15% volatility), it generated thousands of possible future paths. Over a 30-year horizon, roughly half experienced a drawdown larger than 50%, and around 15% suffered losses greater than 70%. Those are estimates that depend heavily on the inputs — but the conclusion is clear.

Simulated odds of breaching each drawdown threshold over 30 years (7% return, 15% vol). A 50%+ loss along the way is close to a coin-flip — too high for my risk tolerance. Source: InvestLab IPS simulator.

The second issue: long-term disappointment

We’re often told stocks always win in the long run. Broadly, that’s true. The problem is that the “long run” can be much longer than most investors realise.

Consider Japan. The chart below shows the range of real returns Japanese equity investors experienced over holding periods from 10 to 121 years. Even after 30 years — an exceptionally long horizon — investors still faced roughly a 25% chance of losing money after inflation. To be highly confident of a positive real return, you’d have needed more than 50 years. That’s an extreme example, but it makes the point: long horizons reduce risk, they don’t eliminate it.

Japanese real equity returns by holding period. Even at a 30-year horizon the bottom quartile is still negative in real terms; the range only converges above zero after ~50 years. Source: Credit Suisse Global Investment Returns Yearbook.

And it’s not just Japan. Across more than 200 years of data and 39 developed markets, Anarkulova, Cederburg & O’Doherty (2022) found investors still faced roughly a 12% chance of ending a 30-year holding period with a real loss. My own analysis points the same way: with global-equity-like assumptions, the IPS simulator estimates roughly a 15% chance of earning less than 2% a year over the next 30 years, a 5% chance of losing money outright, and about a one-in-three chance of earning less than 4% a year.

Simulated odds of finishing below each annualised-return threshold over 30 years. A one-in-three chance of sub-4%/yr — and a real chance of falling short of my 2% floor. Source: InvestLab IPS simulator.

So 100% equities is a perfectly good fit for plenty of investors. Just not for mine — the odds of falling short are simply too high.

Option 2: What about adding bonds?

At first glance bonds seem a strange addition: if stocks return more over time, why hold a lower-returning asset? Because maximising returns isn’t the goal — maximising the probability of hitting your objectives is. And bonds (especially high-quality government bonds) help with that in two ways.

First, they reduce your risk. In recessions, crises and flights to safety, high-quality government bonds have historically provided a valuable cushion — cutting the risk of severe losses and making the portfolio less dependent on any single outcome. It’s like insurance (imperfect, but real) — except that, unlike home or car cover, you’re actually paid a positive expected return to hold it. What’s not to like.

Second, they may cost less return than you think — and can even add to it. A portfolio’s compounded return depends not just on what it earns but on how volatile the ride is. Big losses are especially damaging, because recovering takes disproportionately large gains: a 50% loss needs a 100% gain just to break even; a 50% gain then a 33% loss leaves you flat (not the +8.5% a simple average implies). By shrinking those losses, bonds offset part of the return they appear to give up — and sometimes a diversified portfolio compounds faster than a more volatile one with a higher expected return. That’s one reason diversification is called the closest thing to a free lunch in investing.

Little wonder the default strategic asset allocation for decades has been the classic 60/40: 60% stocks and 40% bonds.

For my own version I make two deliberate departures — I narrow the bond sleeve to high-quality government bonds, long-duration (TLT):

• Government, not credit. I want bonds for diversification — something that rallies when stocks fall. Governments do; corporate and lower-quality bonds largely don’t, because their credit risk bites exactly when equities drop. Too much credit and your “diversifier” is just stocks-lite.
• Long-duration (TLT). It’s pacier — bigger moves, more diversification punch per dollar. With no leverage (most of us), that’s more bang for your buck: real ballast from a smaller slice, leaving room for the return engine. The trade-off: more rate risk (TLT fell ~31% in 2022) and US-centric, so a defensive or local government bond is a fine swap.

Here’s a simple 60% VT / 40% TLT portfolio, extended back to 1990:

The 60/40

60% VT / 40% TLT vs 100% global stocks, 1990–2026 (growth on a log scale, with drawdown below). Same destination, far smoother road. Pre-2008 history is spliced from index proxies; past performance isn’t indicative of future results.

The headline is almost too good. Over 36 years the 60/40 matched all-stocks’ return (7.1% vs 7.0%) with two-thirds the volatility (10% vs 15%), a worst drawdown of −31% vs −55%, and a Sharpe of 0.73 vs 0.52. Same destination, far smoother road — variance drag working for you. But two problems remain.

Problem one: it’s far more concentrated in risk than it looks

You put 60% of your money in stocks — but they supply roughly 80% of the portfolio’s risk, and the blend still moves with global equities almost one-for-one (correlation 0.88). The reason is simple: stocks are far more volatile, so they dominate whatever they’re mixed with.

Problem two: the insurance lapses just when inflation strikes

Bonds did their job in the dot-com bust and 2008 — but not in 2022, when the 60/40 fell about as hard as all-stocks (−27% vs −25%) because long Treasuries dropped −31%, more than equities. The diversifier became an amplifier. Diversification depends on the kind of trouble: in a recession bonds rally as rates fall; in an inflation shock central banks raise rates, hammering bonds (long-duration most) and stocks together — exactly when you needed them apart.

Option 3: What about adding more asset classes?

By now the natural question is: why stop at stocks and bonds? The instinct is right. The trick is not simply owning more assets, but owning assets that behave differently.

Many popular additions don’t help as much as investors think. Private equity and real estate, for example, often look wonderfully diversified on paper. In reality, much of that diversification comes from infrequent pricing. Under the hood they’re still heavily exposed to economic growth and equity markets, and in a serious crisis they tend to suffer alongside stocks rather than protect you from them.

A better starting point is to ask: what actually drives asset returns? Most market environments can be thought of as combinations of two forces — growth and inflation. Each can surprise to the upside or downside, creating four broad economic regimes. Stocks and bonds already cover two of them reasonably well:

• Stocks thrive when growth is strong and inflation stays contained.
• Government bonds do best when growth disappoints and inflation falls.

The problem is that both can struggle when inflation becomes the dominant risk. That’s exactly what happened in 2022. To make the portfolio more resilient, we need assets that help in the remaining environments:

• Reflation (growth and inflation both rising) → commodities. Real assets — oil, metals, agriculture — often benefit directly from rising prices and strong demand. When inflation picks up, commodities are often part of the reason.
• Stagflation (weak growth, high inflation) → gold. Gold doesn’t depend on growth, profits or cash flows. It has historically done best when investors lose confidence in paper assets, real rates fall, or inflation erodes the value of money.

The four growth × inflation regimes, with one building block built to lead in each: stocks for Goldilocks, bonds for recession, commodities for reflation, gold for stagflation — so something is always working.

Together, stocks, bonds, commodities and gold give exposure to a far broader range of outcomes than stocks and bonds alone. So should we just split the portfolio 25% each? Not quite.

As we saw with the 60/40, equal dollars doesn’t mean equal risk. More volatile assets contribute more to the portfolio’s behaviour, regardless of how much capital they receive. That observation sits at the heart of risk parity and Ray Dalio’s All Weather approach: don’t balance dollars, balance risks. There are sophisticated ways to calculate those weights, but let’s keep it simple with a practical version — the all-weather lean:

The all-weather lean

See the full Lean All-Weather one-pager

Notice we’re not aiming for perfect risk balance. Stocks and bonds are productive assets with positive expected returns; gold and commodities are primarily diversifiers and inflation hedges. They’re there to improve outcomes, not to drive long-term wealth creation. Here’s how that portfolio would have performed:

All-weather lean (30% VT / 30% TLT / 20% GLD / 20% DBC) vs 100% stocks, 1990–2026. Stock-like return, a fraction of the pain — and the highest Sharpe of any mix so far.

The pattern should look familiar. Over 36 years this all-weather portfolio matched the return of 100% stocks (around 7% a year) with substantially lower volatility, smaller drawdowns, and the highest Sharpe ratio of the portfolios we’ve examined so far. That’s diversification earning its keep. Even more striking, gold and commodities contributed meaningfully despite generating little long-term return on their own — their value came from improving the portfolio, not from being great standalone investments.

Options 4 & 5: Still want more stocks? Two middle-ground options

Fair enough — not everyone needs a portfolio that’s fully balanced across every regime, and many people would find it too hard to deviate far from stocks. If that’s you, there are two sensible ways to do it.

Aggressive SAA: equities with diversifiers as supporting players

The simplest approach keeps equities as the dominant part of the portfolio and uses bonds, gold and commodities as supporting players. One example:

Aggressive SAA

See the full Lean Aggressive one-pager

At those weights, the portfolio is still overwhelmingly driven by equities — in a major regime shift, you’ll feel it. But the diversifiers can reduce drawdowns, improve resilience, and smooth the compounding. Over 1990–2026 this simple mix actually edged out 100% stocks (7.3% vs 7.0% a year) while cutting the maximum drawdown from −55% to roughly −40%.

Balanced SAA: all-weather with a growth tilt

The next step is closer to an all-weather portfolio, but with a larger equity allocation than a traditional risk-parity approach. Think of it as a growth-oriented all-weather: enough stocks to drive long-term wealth creation, enough diversification to avoid being entirely dependent on one outcome. It’s the shape behind our Lean Balanced strategy.

Balanced SAA

See the full Lean Balanced one-pager

Personally, I think this is one of the strongest starting points for many investors. It has a meaningful growth engine, but enough ballast that you’re more likely to stay invested when markets get difficult. Over our sample it actually outperformed every portfolio we’ve looked at so far — beating 100% stocks by almost a full point a year (8.2% vs 7.3%) while keeping volatility low (9.3%) and drawdowns relatively modest (−27%). Here’s how the two stock-heavy options compare:

Balanced and Aggressive vs 100% stocks, 1990–2026. Both keep most of the upside; the balanced mix actually beat stocks over this window, with far smaller drawdowns.

How much should we trust any of this?

The numbers above describe one past, not the future — so trust the shape of the trade-offs, not the exact magnitudes. A few reasons to stay humble.

So why trust any of it? Not because of the backtest, but because of economic logic. Each asset is tied to a different engine: stocks to growth, government bonds to falling growth and deflation, commodities and gold to inflation. Hold all four and, whatever the economy throws at you, something is built to do well. Since nobody can know which regime comes next, owning assets that each thrive in a different one is simply safer — a conclusion that would hold even if markets had never produced a single data point.

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Figures from InvestLab backtests over 1990–2026; pre-2008 history uses spliced index proxies. “Chance of” figures come from the InvestLab IPS simulator and are estimates, not forecasts. Past performance does not guarantee future returns. Educational, not personalised investment advice.