Asset allocation is an investment portfolio technique that aims to balance risk and reward by distributing a portfolio's assets among major categories of asset classes according to an individual's goals, risk tolerance and investment horizon.
Each asset class has different levels of risk and return, so each will behave differently over time. While one asset is increasing in value, another may be decreasing or not increasing as much.
Most financial professionals agree that asset allocation is one of the most important decisions in constructing investment portfolio. It is the principal determinants of your investment results. In other words, selection of individual securities is secondary to the allocation of investment portfolio among asset classes.
In general, a portfolio of long-term investment should be comprised mostly of stocks. It’s widely known that throughout history common stock has outperformed most financial instruments; and stock has also showed the highest volatility. However, investors who invest for shorter period of time or are risk-averse individuals should include asset classes other than stocks in their portfolio. The older a person gets, the less risk she should engage, thus the less stocks (the more bonds and cash equivalents) she should allocate in her investment. After a person retires, she should invest more conservatively because asset preservation is crucial during this time. She may have to depend on her savings as her only source of income. This is the underlying principle of asset allocation.
Determining the proper mix of investments in your portfolio is extremely important. Deciding what percentage of your portfolio you should put each asset class isn't straightforward.
To determine your asset allocation plan, you should speak to your investment advisor who can customize a right portfolio for you situation.