Asset allocation is the process of diversifying an investor's money between different asset classes, including stocks, bonds and cash investments. Each investor may have a different asset allocation strategy based on their time horizon and personal risk tolerance. It is wise for investors to annually examine and potentially rebalance their current asset allocation. Over time, their asset allocation strategy may change depending on life circumstances, such as retirement.
Determine how much money in investments you currently have to diversify. Also, determine how much money you will continue to add to your diversified portfolio.
Establish your time horizon--when you will need to tap into your portfolio of investments. For example, decide if you will need the money short-term to buy a house, or if you will need it long-term during retirement.
Take a risk tolerance quiz to determine your personal level of risk tolerance. Risk tolerance is your personal ability to withstand both positive and negative swings in the value of your portfolio of investments.
Select a diversified portfolio of stocks, bonds and cash investments dependent on your predetermined personal risk tolerance and time horizon. For example, investors with an aggressive risk tolerance or long-term time horizon may have their investment portfolio weighted more heavily in stocks. Whereas, investors with a conservative risk tolerance or short-term time horizon may have their investment portfolio weighted more heavily in bonds and cash equivalent investments.
Examine your diversified portfolio's asset allocation at least annually to determine if you need to rebalance your current asset allocation. You may also need to rebalance if your life situation changes.