• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

Free From Broke

A Personal Finance Blog for Regular Folks

  • Home
  • Personal Finance
  • Debt
  • Saving
  • Investing
    • Best Online Brokerages
  • Taxes
  • Credit Scores
You Are Here: Home » Investing » What is Asset Allocation?

What is Asset Allocation?

Published or updated May 23, 2013 by Glen Craig

What is Asset Allocation?

Different buckets for asset allocation
Different buckets for asset allocation

Asset allocation is an investment strategy that is used to choose among various asset classes such as stocks, bonds, commodities, foreign currencies, real estate, annuities and life insurance, and high value collectibles including precious metals.

Asset allocation as a way of investing is an important part of a person’s financial planning process that primarily concerns the very relationship of an investment portfolio’s risk and return.  Different asset classes offer different risks and returns as long as their performances are not perfectly correlated (if they go up and down in the same market conditions).  Asset allocation reduces the volatility of investment results when not all investments in the portfolio rise and fall at the same time.

How is Asset Allocation Related to Investing?


In essence, investing is about growing capital over time.

But any investment’s future performance is uncertain and likely experiences fluctuations in price or value from time to time.  Such potential investment risks are not uncommon in commodities, foreign exchanges, and certainly in stocks as well.  To mitigate a particular type of risk uncertainty in an individual investment, derivative hedging, such as futures, options and swaps, has been widely used to smooth out expected future price fluctuations. Hedging eliminates the possibility of both incurring bigger losses and reaping in higher returns, but in exchange, helps achieve a level of certainty in investment results.  Comparable to risk management of individual investments, asset allocation is a way of hedging in portfolio situations.  Each investment class serves as a hedge for the other investment class.  As a result, when one investment loses, the other gains and total investment results of the entire portfolio are smoothed out to reach a give level of expected return.

Why is Asset Allocation Important?

Asset allocation can be considered as a form of passive investment management.

Once investment funds are allocated among asset classes based on the set percentage or weights, it is important for average investors to stick with the plan, except periodic portfolio adjustments.  Active investing of buying and selling by jumping from one asset to another not only would require time, resources and expertise, but also might end up with worse results than following a consistent plan.  The most representative of passive management is index funds investing and its popularity has risen steadily.  Index funds use the same asset allocation idea and consist of a portfolio of different securities that either replicates or resembles an existing, known market index or follows an fund’s own proprietary index.  Index investing, as well as asset allocation method, ensures that the worst investment results never happen.

How can Asset Allocation be Done?

The process of asset allocation can be summarized as: define investment goals with the relative risk tolerance, choose the range of diversification, and assign weights to each asset class.  Age, expected future major expenditures, the level of future earned income, etc… are factors to consider when trying to define investment goals and decide how much risk to take on.  In addition to different asset classes, asset allocation also concerns the diversification of investment style particularly in equity investments, a major asset class.  Choose among large, mid, and small caps or growth, value and blend.  Finally, based on the different rates of return on the chosen asset classes, assign multiple sets of weights to each asset class and compare the total weighted average rate of return under each set of weights with one another and against the expected investment return as defined in the investment goals.

To summarize – Asset Allocation deals with putting your investments in different asset classes to help spread out market risk.  This helps smooth out the overall return of your portfolio over different market conditions.

How do you allocate your portfolio assets?

Filed Under: Investing Tagged With: asset allocation, bonds, Stocks

About Glen Craig

Glen Craig is married and the father to four children that he spends the day chasing as a stay-at-home-dad. He took an interest in personal finance when he realized most of his paycheck was going toward credit card bills. Since then he's eliminated his credit card debt and started on a journey towards financial freedom.

Reader Interactions

Comments

  1. Matt says

    September 9, 2010 at 8:25 am

    Thanks to the proliferation of mutual funds, an individual can now not only invest in different “asset classes” of stocks, but also can use funds to invest in precious metals (usually metals mining companies/stocks), real estate (REITs), shorting stocks (betting that a stock or asset class will fall in price), or other non-stock assets. In addition, peer-to-peer lending has opened up a new type of “asset” class to invest in (Lending Club, for example).

    • ffb says

      September 9, 2010 at 11:40 am

      I think now, more than any time before us, the average person has a much greater choice of investment and a much greater ease of investing in them.

      The hard part is choosing what to invest in. But starting with asset allocation can help one get a broad range of investments to weather the market.

  2. Jenna says

    September 9, 2010 at 10:54 am

    Right now my assets aren’t so great, Roth IRA, money market accounts, some stocks and hopefully real estate soon.

    • ffb says

      September 9, 2010 at 11:41 am

      You can totally invest in a wide range of asset classes in a Roth IRA. What you pick is up to you.

      • Jenna says

        September 9, 2010 at 12:56 pm

        Really? How do I do that?

        • Matt says

          September 9, 2010 at 1:17 pm

          Using a mutual fund provider (I use Vanguard; other big names are Fidelity, Janus, etc.) you can pick and choose which asset class you wish to invest in. Vanguard has screening tools that let you choose what type of stock fund, bond fund, or other types of funds you’re interested in. For beginning investors, a conservative stock mutual fund is the way to go until you get a feel for what your are doing. I’m not a shill for Vanguard BTW, but they offer many types of low- or no-fee mutual funds (including index funds) that are ideally suited for beginning investors.

          • ffb says

            September 9, 2010 at 9:36 pm

            To further that, you can pick a broad index that will invest in all stocks and another that invests in all bonds.

  3. Suba @ Wealth Informatics says

    September 9, 2010 at 1:46 pm

    Right now most of our assets is in stocks, stock mutual fund I mean. I would like to add some precious metals and REIT ones too. I was wondering if there is any advantage to buying precious metal mutual funds instead of buying just buying precious metals, like gold coins. I can think of storing them and worrying about keeping it safe. Other than that, I am not sure. I have to read up on them… I really need to add some other asset classes to my portfolio.

    • ffb says

      September 10, 2010 at 12:05 am

      My thoughts on precious metals versus the funds is this – how do you know you will be ale to sell the actual metals when you need to? Will you be able to find somewhere to give you fair market value?

      A fund you can sell virtually any time.

      I’m thinking 10-20 years down the line. Gold is very popular these days but who’s to say there will be as many places buying it in the future?

      And of course storage is huge too.

  4. Barb Friedberg says

    September 12, 2010 at 5:01 pm

    You probably know that 90% of returns come from asset allocation; it is really the only thing close to a “free lunch.” I’m uncovering my asset allocation this month in a special series on my site. You did a fabulous job breaking down this important concept.

    • ffb says

      September 12, 2010 at 7:02 pm

      Thanks Barb!

Primary Sidebar

A Little About Me

Glen CraigI'm Glen Craig - I used to live paycheck-to-paycheck, drowning in credit card debt. I turned that all around and now I build wealth rather than debt.

My goal is to make personal finance easy for you.

More ABOUT me.

Join our email list (FREE) and never miss an article!


Free From Broke as seen on

Follow Us

FacebookGoogleTwitterRSS



Follow @freefrombroke

Top Articles

  • Use Google Calendar To Pay Your Bills On Time
  • 9 Things to Do When You Retire
  • Side Hustle-Make Extra Money Cleaning Homes
  • Four Ways You Can Pay Off Your Home Mortgage Faster
  • Don’t Forget Your 401(k) When You Leave Your Job! Here’s What You Can Do With It
  • Your 4 Step Guide on How to Stop Living Paycheck to Paycheck
  • What Is A Mortgage Escrow Account?
  • This is Why Your House Isn’t Selling – Here’s How to Finally Get Your House Sold
  • 7 Ways to Get Rich Quick
  • What is Renter’s Insurance and Why You Need It
  • What Is a Probate Lawyer and When Would You Use One?

Recent Articles

  • Money Market Account VS Savings Account – What’s the Difference?
  • Five Ways Fantasy Baseball is Like Personal Finance
  • Tools to Help Organize Your Taxes
  • Don't Let Your Goals Fizzle Out! - 5 Reasons Goals Fail, and What You Can Do To Make Yours Succeed
  • What Do You Think of New Year's Resolutions?

Tools to Improve Your Finances

  • Online High Yield Savings
  • All About Online Checking Accounts – Why Pay More Fees Than You Have To
  • Personal Capital Review - A One Stop Financial Center
  • Online Brokerages That Won't Break Your Bank
  • Credit Karma Review - Get Your Credit Score and More
  • CD Rates
  • Savings Rates
  • Mortgage and Refinance Rates
TurboTax Review HR Block Review Shoeboxed Review

Follow Us On Pinterest!

Follow Free From Broke's board Most RePinned and Popular {Free From Broke} on Pinterest.

Footer

More

  • About
  • Archives
  • Contact Us
  • Get Our Newsletter

More Recent Articles

  • Think Long Term When Shopping Black Friday and Cyber Monday
  • 10 Essential Tips For Shopping Black Friday And Cyber Monday That Will Save You Money
  • How to Improve Your Credit Score Fast
  • What is a Refund Anticipation Loan (RAL) and is it Worth It?
  • Paying Taxes with a Credit Card: Pros and Cons

Disclaimer

Free From Broke is for general information or entertainment purposes only and does not constitute professional financial advice. Be smart and do your own research or contact an independent financial professional for advice regarding your specific situation.

In accordance with FTC guidelines, we state that we have a financial relationship with companies mentioned in this website. This may include receiving access to free products and services for product and service reviews and giveaways.

© 2007–2025 Free From Broke A Personal Finance Blog For Regular Folks – All rights reserved.

No content on this site may be reused in any fashion without written permission from FreeFromBroke.com | Privacy Policy | Sitemap

Copyright © 2025 · Metro Pro on Genesis Framework · WordPress · Log in

We are using cookies to give you the best experience on our website.

You can find out more about which cookies we are using or switch them off in settings.

Go to mobile version
Powered by  GDPR Cookie Compliance
Privacy Overview

This website uses cookies so that we can provide you with the best user experience possible. Cookie information is stored in your browser and performs functions such as recognising you when you return to our website and helping our team to understand which sections of the website you find most interesting and useful.

Strictly Necessary Cookies

Strictly Necessary Cookie should be enabled at all times so that we can save your preferences for cookie settings.

If you disable this cookie, we will not be able to save your preferences. This means that every time you visit this website you will need to enable or disable cookies again.