Choose your asset allocation

Whether you decide on mutual funds or ETFs, you will have to choose an asset allocation.
Asset allocation is a fancy term that simply means how much bonds, stocks, and cash you have in your investment portfolio. For most people, cash is not part of their portfolio. So you can focus solely on bonds and stocks. Your cash will stay separated from your investment portfolio.
Now, there are no good or bad asset allocations. You need to know the difference between different asset allocations and choose one that suits you personally!
We have already seen that stocks are more volatile and have higher returns. On the other hand, bonds are more stable but will bring lower returns.
Based on that, your asset allocation should be chosen based on these factors:

1. Your risk tolerance. How much risk are you capable of handling? If your portfolio is down 30%, what will you do?
2. Your investing term. How long will you be investing before you will need this money?

Having a good risk tolerance means the ability to take on more stocks. And a long investing term also means you can have more stocks in your portfolio. But do not take these two factors independently. You need to consider them both.
For instance, if you need the money in 20 years (very long-term) but have a low risk tolerance, you should have a significant amount of stocks regardless.
You should not even consider having less than 40% of stocks. You need stocks to have good returns. Here are the most popular asset allocations:

• 100% of Stocks: Investing for the long-term and excellent risk tolerance.
• 80% of Stocks: Investing for the long-term and good risk tolerance.
• 60% of Stocks: Investing for the medium-term or average risk tolerance.
• 40% of Stocks: Investing for the medium-term or low risk tolerance.

These are only rules of thumbs, of course. Nothing prevents you from a 75/25 portfolio. It would be a perfectly fine portfolio.
And one last thing on asset allocation: It does not need to set in stone. You should not change it often. But you can change it. First, as you age, your risk tolerance may change. And as you get closer to your term, you may want to increase the bonds to avoid a big surprise.