Put simply, it's the strategy behind the types of investments held in a portfolio.
There are dozens of different asset classes.
In which ones should an investor put his or her money?
How much of an investor's portfolio should be devoted to each?
These are the questions that an asset allocation strategy can answer.
Why bother with asset allocation?
Investors today can invest in stocks from companies in the United States, Europe, the Pacific Rim, and emerging markets around the world. They can invest in big companies, medium-sized companies, and small companies. They can invest in bonds issued by governments and thousands of companies around the world. They can invest in real estate, precious metals, and commodities. All of these options can overwhelm anyone. Does a wise investor divide his or her money among all of these different asset classes, or pick just a few? How much of an investor's portfolio should be devoted to each?
There is not a uniform answer to these questions. People have different situations and goals, and as a result, no unique "correct method" exists. However, there are principles that can guide investors and help each one determine the right asset allocation. Once their asset allocation is set, investors can use it to filter all of their other investment decisions, ensuring that they maximize the chances of reaching their goals.
The importance of asset allocation in determining an investor's overall return and exposure to risk should not be underestimated—studies have shown that it is one of the most significant factors influencing portfolio performance. In fact, as much as 90% of a portfolio's variability and 100% of its return over time is explained by asset allocation (Ibbotson, 2000). Other factors, such as market timing, costs, and security selection, have a lesser impact. As a result, many experts suggest that asset allocation is the most important decision an investor can make.
The purpose of this Wikibook is to provide readers with general guidance in selecting an appropriate asset allocation policy for their investing needs and goals, based on current research and recommendations from experts.