Asset Allocation is the most influential factor in the performance of a diversified portfolio.
Asset allocation involves combining various asset classes within a portfolio for the purpose of achieving greater expected returns with less price fluctuation. An asset class can be defined as a group of securities with shared economic traits and each asset class is intended to play a different role within a portfolio. An example of an asset class would be domestic large cap equity, or international small cap equity. The positive results from proper asset allocation is a direct result of the combined differences in such asset classes, the whole is greater than the sum of its parts.
The main determinant in identifying an investor’s asset allocation is their appetite for risk or risk tolerance. In general, a portfolio more heavily weighted towards stocks would be considered aggressive, while a portfolio with a great allocation towards fixed income would be considered conservative. Every investor has a unique risk tolerance accompanied by varying life goals and circumstances. Each of these components plays a vital role in determining an investor’s asset allocation.