What Is an Asset Allocation Plan?

Jim B.
Jim B.
Woman holding a book
Woman holding a book

An asset allocation plan is a process by which an individual investor chooses where and how much of his or her investment capital will be spent. This is done by deciding among several different asset classes according to their levels of risk and their potential for returns. Most investors choose an asset allocation plan for investing based on their individual circumstances and goals. Ideally, assets will be diversified so that risks will be minimized and capital will be exposed to a broad range of lucrative markets served by various financial instruments, like stocks, bonds, or commodities.

Thinking about investments as a series of individual ventures can prove to be a mistake. If there is inconsistency, in terms of acceptable risk or desired returns, among the types of investments sought out, the overall result can be far from what an investor desires. As a result, it can be useful to think of one’s entire portfolio as a broad extension of an investor’s goals for his or her capital. Devising the proper asset allocation plan is essential to reaching those goals.

One of the key aspects of any asset allocation plan is the identification of what an investor wants from his or her capital. If the idea is to provide for retirement, long-term, fixed income investments like bonds or stocks that pay steady dividends should make up the bulk of a portfolio. By contrast, an investor seeking more aggressive growth over a shorter period of time should be seeking stocks from companies that are unproven but have good potential.

Balancing out acceptable risks with desired returns is another important part of an asset allocation plan. Investors should also be aware of the volatility attached to each potential investment. Volatility is a measurement of how much the value of an investment changes in a certain period of time. Depending on the goals of a portfolio, investors might steer away from certain securities that are especially volatile. Still, some volatile securities can eventually be extremely profitable after the ups and downs pass.

It is a general rule in constructing an asset allocation plan that there should be a great amount of diversity involved. By picking assets from different sectors of the market, investors are protected from a downturn in one specific sector. Other assets in a diversified portfolio could cover for one or more underperforming assets from sectors that are struggling. Diversity also means that an investor has exposure to a plethora of investment opportunities, thus increasing the chances for profits.

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