Asset Allocation Basics: Building an Investment Mix

Asset allocation is the process of dividing an investment portfolio among asset classes such as stocks, bonds and cash. The mix an investor chooses can strongly influence both the portfolio’s potential return and the types of risk it experiences.

There is no universal allocation

An appropriate mix depends on the investor and the goal. Two people of the same age can reasonably have different allocations because their time horizons, financial situations, goals and tolerance for market losses may differ.

Different asset classes can play different roles

Stocks are commonly used for long-term growth potential. Bonds may provide income and can sometimes reduce portfolio volatility relative to an all-stock portfolio. Cash and cash equivalents may provide liquidity and stability for shorter-term needs, though inflation can erode purchasing power.

Asset allocation and diversification are related

Asset allocation spreads money among asset classes. Diversification spreads exposure among multiple investments, including within each asset class. Holding several narrowly focused investments does not necessarily create meaningful diversification.

Your allocation can drift

If one asset class rises faster than another, its portfolio weight can grow beyond the intended target. Rebalancing means bringing the portfolio back toward its chosen allocation, either by trading, directing new contributions, or both.

Review the plan as life changes

A portfolio may need to evolve as a goal approaches or as an investor’s financial circumstances and risk tolerance change. Changes should be based on the plan rather than on an attempt to chase whichever asset class recently performed best.

Educational note: This article is for general educational purposes and does not provide individualized investment, tax, or legal advice. Investing involves risk, including possible loss of principal.