What is Asset Allocation and what is it's
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The first purpose is to achieve diversification. This is
investment group or asset class will not be correlated
much as possible. For example, stocks will all tend to
move up or down together. The single most important
factor in whether at stock goes up or down is where
the stock market as a whole has moved. In other as
an asset class first, moving the entire market,
affecting the direction of all stocks.

The Bond market, however, will be less correlated
with the stock market. That is, when the stock market
moves up 2%, the bond market will likely not have a
similar gain. To be more precise, if the stock market
makes a given % daily average growth over a
hundred days, the bond market will likely have made
returns that bear very little resemblance to this return.
Their expected correlation is moderate or low*. But,
on average, one stock’s correlation with another is
high. Similarly, one bond’s correlation with another
bond is also, on average, high.

The same is true for other asset classes, such as
commodities and Real Estate, and others.

So an investor needs to spread his/her money among
the different asset classes to diversify and decrease
the risk. The next question is what percentage of
money to put in each class. That depends on the risk
profile** of the investor. That is, how much expected
return does he/she want and how much risk are they
willing to take to get it? If they are willing to take more
risk for a return, they will be more heavily weighted
towards the stock market, commodities and real
estate. If they are willing to less risk they will be more
heavily weighted towards the bond market and cash
equivalents (money market accounts, etc.).  

An example of an asset class split for a higher risk,
higher return portfolio would be:

60% Stocks
25% Bonds
10 % Real Estate
5% Commodities/Other

An example of a lower risk, lower return portfolio
would be:

20% Stocks
60% Bonds
20% Money Market (or other interest bearing cash

A careful evaluation of the investor’s risk profile needs
to be made to determine how their portfolio should be
divided into asset classes.  It is best to consult a
qualified professional to help one perform this
evaluation. Then one can proceed to the next step in
the investment process, which is where the investor
should put her/his money within each asset class.


*Why aren’t bonds and stocks highly correlated (why
don’t they tend to move closely move together)?
Stocks represent an ownership position in a
company. As such, the investor can reap the full
spectrum of returns from an investment, from wild
growth returns, down to a total loss. Bonds are debt
instruments, and are only a payment claim on a given
company. Generally the long term returns on a bond
security are known and fixed up front. Even if a
company performs poorly, the bondholders will
generally still receive the same payments and return.
Of course this may not be true if the company gets
into severe difficulty or bankruptcy. But the chances of
not receiving this return are much less likely than poor
returns on a stock. Therefore the bond market
represents lower long-term expected returns, and
lower risk than the stock market.      

** This in turn is normally influenced by their time
horizon, or when they will need their money.  

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