Asset allocation is the process of dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The goal of asset allocation is to diversify investments and to balance risk and reward. By spreading investments across different asset categories, an investor can potentially reduce the risk of losing money and increase the chances of earning a positive return.
Asset allocation is based on the principle that different asset categories have different levels of risk and return, and that by diversifying investments across different asset categories, an investor can reduce overall portfolio risk while still maintaining a chance for a reasonable return.
The most common asset categories are:
- Stocks (also known as equities): investments in the ownership of companies, which can provide the potential for high returns but also carry a higher level of risk.
- Bonds: investments in the debt of companies or governments, which tend to be less risky than stocks but also have lower potential returns.
- Cash and cash equivalents: investments such as savings accounts, money market funds, and short-term bonds, which tend to be the safest but also have the lowest potential returns.
Asset allocation is an important part of any investment strategy, and it is recommended to review and adjust your asset allocation periodically to ensure that it aligns with your investment goals and risk tolerance. It is also important to note that asset allocation does not guarantee a profit or protect against loss.