Asset allocation refers to the way in which you weight investments in your portfolio in order to try to meet a specific objective. For instance, if your goal is to pursue growth (and you’re willing to take on market risk in order to do so), you may decide to place 20% of your assets in bonds and 80% in stocks. The asset classes you choose, and how you weight your investment in each, will probably hinge on your investment time frame and how that matches with the risks and rewards of each asset class
Focus on the Three Primary Asset Classes: Stocks, Bonds, and Money Markets
Diversification: The Basis of Asset Allocation Before exploring just how you can put an asset allocation strategy to work to help you meet your investment goals, you should first understand how diversification — the process of helping reduce risk by investing in several different types of individual funds or securities — works hand in hand with asset allocation. When you diversify your investments among more than one security, you help reduce what is known as "single-security risk," or the risk that your investment will fluctuate widely in value with the price of one holding. Diversifying among several asset classes may increase the chance that, if and when the return of one investment is falling, the potential return of another in your portfolio may be rising (though there are no guarantees and the total value of your portfolio may decline)
Points to Remember
» Asset allocation is the way in which you spread your investment portfolio among different asset classes, such as stocks and stock mutual funds, bonds, and bond mutual funds.
» When prices of different types of assets do not move in tandem, combining these investments in a portfolio can help manage the variability of returns, commonly referred to as "market risk."
» Mutual funds are pools of securities, usually offering diversification within a single asset class. Some mutual funds may include several asset classes.
» The asset allocation that is right for you depends on your investment time frame, goals, and tolerance for risk.
» As your investment time frame and goals change, so might your asset allocation. Many financial experts suggest re-evaluating your asset allocation periodically or whenever you experience a milestone event in your life such as marriage, the birth of a child, or retirement.