Diversifying your funds among different types of investments is an important way to minimize your investment risks. It can also play a large role in the return you can expect. In fact, how you allocate your investments among asset classes (stocks, bonds, mutual funds, etc.) may be the most important factor, by a significant margin, in determining portfolio performance. That means making asset allocation choices should be one of your first steps in the investment process.
The objective of any asset allocation plan should be to find the asset mix that provides the appropriate combination of expected return and expected risk that will allow you to achieve your financial goals. Choosing the optimal asset allocation for your investments can, however, be extremely difficult.
The asset allocation most appropriate for a single, 32-year-old investor who is earning $75,000 a year might be quite different from that of a 55-year-old with two children in college who is planning for retirement. But whatever your situation, the right investments for you will be those with potential rates of return that can help you meet your financial goals with risk levels you find comfortable.
Two factors involved in choosing your appropriate asset allocation are your time frame and your risk tolerance. Also important is understanding the current economic conditions and how they affect your investment opportunities.