Asset allocation is the process of distributing wealth among different investment types, most typically stocks, bonds, and cash. Asset allocation attempts to increase potential return and reduce risk in portfolios over time.

Research has shown asset allocation decisions are the most important factor affecting overall portfolio performance. While this process can be performed on any portfolio with two or more assets, it is most commonly applied to the asset classes mentioned above—stocks, bonds, and cash. Studies between 1991 and 1995 demonstrated that allocation choices between these broad classes may account for more than 90% of the return of the portfolio.*

The idea behind this diversification into different investments is that each asset class will generally have different levels of return and risk and behave differently. While one asset class may be increasing in value, another may be decreasing or not increasing as much and vice versa. Since most investors want to maximize return and minimize risk, the decision to “not put all your eggs in one basket” by allocating over different asset classes attempts to achieve this goal.

*Determinants of Portfolio Performance, Brinson, Hood, and Beebower, Financial Analysts Journal, July/August, 1996.

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