Your mix of stocks, bonds, and cash is called your asset allocation. Diversification spreads money both across asset classes and within them; it does not prevent every loss. This chapter explains their different roles, why bonds can lose value, and how to recognize and correct a mix that has drifted.
Three buckets, three jobs
Stocks represent ownership in businesses, with the possibility of growth but also sharp falls and permanent losses. Bonds are loans to governments or companies, with promised payments under stated terms. These are different claims on future money, not interchangeable ways to earn a return.
Here, cash means readily accessible bank deposits in the currency used for the goal. Inflation can reduce what the balance buys. Fees, access conditions, and local deposit-protection rules still matter. Money market funds are investments, not insured bank deposits.
Mina sets aside a fictional $10,000, separate from her living costs, near-term bills, and emergency reserve. She divides it into $6,000 in stocks, $3,000 in bonds, and $1,000 in cash. These round numbers are for learning, not a recommended mix. A real allocation depends on the goal, time available, and both willingness and financial ability to bear losses, as Investor.gov explains.
Bonds can fall too
A payment promise does not remove risk. Three important risks are:
Interest-rate risk. Suppose a conventional fixed-rate bond pays 3% a year and comparable new bonds issued at face value pay 5%. Other things being equal, the existing bond's market price generally falls to offer a competitive yield. For otherwise similar bonds, longer maturity generally increases sensitivity, but maturity and duration are not the same. Duration measures interest-rate sensitivity and also reflects factors such as coupon payments and yield. Higher duration generally means a larger price change for the same change in yield.
Credit risk. A company or government may pay late or fail to pay. Weaker credit quality generally requires a higher yield to attract investors. That higher yield compensates for risk; it does not remove it.
Inflation risk. Fixed payments buy less when prices rise.
Holding an individual bond to maturity can avoid having to sell at a depressed market price, provided the issuer pays as promised. The promised repayment is its face value, not necessarily the price you paid. Holding shares in a bond fund is different: return of the amount invested is not guaranteed, even if the fund holds bonds until they mature.
Sources: SEC on fixed-rate bond risk, FINRA on duration, and SEC bond basics.
Why your mix drifts
Suppose Mina's stocks rise 25% while her bonds and cash stay unchanged. For simplicity, the example ignores income, fees, and taxes.
| Asset | Starting value | Later value | Later share |
|---|---|---|---|
| Stocks | $6,000 | $7,500 | 65.2% |
| Bonds | $3,000 | $3,000 | 26.1% |
| Cash | $1,000 | $1,000 | 8.7% |
| Total | $10,000 | $11,500 | 100% |
Each share is the asset's value divided by $11,500. The original 60/30/10 mix has become 65.2/26.1/8.7 without a single trade. More of the portfolio is now exposed to stock-market movements. Drift is not an error, but it can move a portfolio away from its intended balance.
Rebalancing puts the mix back
Rebalancing restores target weights. If Mina keeps the same target and moves money within her $11,500 portfolio, she would sell $600 of stocks, put $450 into bonds, and keep $150 as cash. The resulting stock, bond, and cash amounts are $6,900, $3,450, and $1,150: 60/30/10 again.
Alternatively, if she were already planning to add savings, she could restore the same weights without selling by adding $750 to bonds and $250 to cash. The total would then be $12,500. Adding this $1,000 is an alternative in the fictional example, not a requirement or recommendation.
A calendar approach reviews the allocation on set dates. A threshold approach responds when a weight moves a chosen distance from its target, measured in percentage points. Neither is prescribed here. Trades may incur fees and taxes, and new contributions may not be enough to restore the target immediately.
The aim is to maintain a chosen allocation, not predict prices. Restoring weights does not guarantee the same risk as before: market conditions and the holdings themselves change. If the goal or circumstances change, the target may need review too.
Source: SEC on rebalancing methods, costs, and taxes.
Practice and check your understanding
On paper, choose a fictional starting mix, an event that would change it, and a method for reviewing it. Note one question you would need answered before using real money.
- If stocks rise while bonds and cash stay flat, does the stock share rise or fall? It rises, even without a trade.
- What generally happens to a conventional fixed-rate bond when market yields rise, other things being equal? Its price falls. Higher duration generally means greater sensitivity.
Before this chapter: Make a Simple Money Plan and Investment Risk and Diversification.
Next: Stocks, Mutual Funds, and ETFs and Compounding, Fees, and Inflation.
Educational content only, not personalized financial advice or a recommended asset allocation. Investing involves risk, including possible loss of principal. All examples are fictional. Sources checked October 26, 2026 (Japan time).