Asset allocation means spreading your investments funds across many asset categories. As an investment strategy, this will help investor balance the overall portfolio risk, volatility, and performance. Asset allocation is an important construct to use when designing a portfolio. The goal is not picking or choosing specific securities, instead it is a focus on the overall architecture or broad investment categories that will ultimately mix together to help you meet your financial goals by factoring in your risk tolerance and time horizon.

Asset Allocation basics The main idea behind asset allocation is that since not all investments follow a similar cycle, you are able to balance out the different risk and return cycles in your portfolio by spreading your investment dollars among different asset classes such as stocks, bonds, real estate, commodities, and other assets. It certainly doesn't guarantee a profit or protect you against losses, but it can help you manage the amount of risk you face.

Different types of asset classes bring different levels of risk and potential for return to a portfolio, and they generally react to different market forces in their own ways and possibly at different times. The effects of a real estate market may hit the real estate sector first but perhaps affect the stock market at a later time. So while the returns of one asset class may be declining, another asset class may be growing. If you diversify your portfolio to include many different types of assets, a market downturn or swing in one asset won't necessarily wreak havoc on your entire portfolio.

Your Financial Advisor can help identify the types of asset classes that may be appropriate for your specific investment objectives and risk tolerance, and then allocate funds to each class say 70% to stocks, 20% percent to bonds, and 10% to real estate).

The major asset classes Below are the three major asset classes you'll generally take advantage of when creating an asset allocation.

Stocks: Stocks have historically provided investors with a higher average annual return than other types of investments such as bonds or cash alternative. Needless to say, because of their potential for higher returns, stocks are typically more volatile and carry a greater degree of risk than other asset classes such as bonds and cash alternative. Investment in stocks may be suitable for those investors that have a longer investment time horizon.

Bonds: As mentioned earlier, bonds have historically been less volatile than stocks. Bonds do not provide opportunity for capital appreciation that stocks can potentially provide. However, they may be appropriate for investors looking for a fixed and stable income stream from their investments. In addition, bonds carry interest rate risk with them. When interest rates rise, bond values tend to fall, and when interest rates fall, bond values tend to rise.

Cash alternatives: Do not provide much capital appreciation potential or income potential but are the least volatile and risky of the three major asset classes. Nevertheless, they are subject to inflation risk. They are generally highly liquid investments and provide investor with easier access to funds than longer-term investments such as stocks and bonds. Cash alternatives may be suitable for investors with short-term investment goals.

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