What is an asset allocation?

Asset allocation is the process of diversification of potentially risk investment in a portfolio suitable for the risk tolerance of individual investors. The main function of the financial planning industry is the investment equivalent of the proverb: "Do not put all eggs in one basket."

The basics of asset allocation consist in MPT or modern portfolio theory. MPT is a formal way of quantifying the risk of any asset. It also provides tools to determine how best to combine these assets into diversified portfolios with a relatively low risk. It attempts to allocate assets to unify this quantitative analysis with the objectives and tolerance of the individual investor to create an optimal investment portfolio. In terms of risk, the safest of them are government bonds and the strongest are shares with high growth that can actually go to zero. Others move in between, depending on the economic conditions. It is also important to consider how long the investor has to get back possible losses.

As potential returns are usually inversely proportional to the risk, the assignment of an asset for a worker near retirement will be distorted to investment, such as government bonds that offer a high level of security in exchange for lower return. On the contrary, the recent university grad has little to lose and would be better operated by a portfolio that takes a high level of risk in exchange for the opportunity to generate large returns. Asset allocation for such an individual would more likely contain speculative shares and mortgages.

Some investments can be considered protection or securing against unexpected events. For example, the allocation of assets with a significant exposure to precious metals can also expose foreign currencies to the devaluation of the basic currency of the investor.