<#-- Rebranding: Header Logo--> <#-- Rebranding: Footer Logo-->
  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion

Investors looking to make an investment for a long period of time tend to focus their portfolios on stocks. One reason for this is that common stock tends to outperform most other financial instruments over a long enough timeframe. Investors who are looking to maximize returns over a shorter period, on the other hand, often diversify their portfolios by including investments other than stocks.

It is this principle that helped to guide the development of the concept of asset allocation. Asset allocation refers to an investment technique which aims to balance risk and create diversification within a portfolio by dividing assets across a number of major categories (stocks, bonds, real estate, cash, etc.). Because each asset class in the portfolio experiences different levels of risk and return, each tends to behave differently over a longer span of time. While one type of asset may be increasing in value, another may be decreasing.

One central tenet of the concept of asset allocation is that older investors tend to look for lower levels of risk. After retiring, an investor may need to depend upon savings as the only source of income. Individuals at or nearing retirement age tend to invest more conservatively, as it’s crucial that they preserve their assets at this stage.

How does one go about determining the correct mix of different types of assets in a portfolio? Like many of the other concepts covered in this tutorial, the answer is complicated and depends on who you ask. There are many different approaches to allocating assets. There are a number of general principles (see: Achieving Optimal Asset Allocation), but the most common approach is to shift emphasis toward lower-risk instruments (like bonds and treasuries) as one gets closer to retirement. Of course, a stock market crash or other significant disturbance can still cause problems for those who invest conservatively, as many investors saw in the bear markets of 2000 and 2001. To best determine the course of action for you, it’s recommended that you speak with a professional investment advisor.

In the next chapter, we’ll explore the randomness of the stock market in the “random walk theory.”


Financial Concepts: Random Walk Theory
Related Articles
  1. Financial Advisor

    An Introduction to Asset Allocation

    A portfolio is only as strong as its asset allocation. To create the right one, investors need to determine their risk tolerance, time horizon and goals.
  2. Managing Wealth

    Achieve Optimal Asset Allocation

    Minimize risk while maximizing return with the right mix of securities and achieve your optimal asset allocation.
  3. Investing

    6 asset allocation strategies that work

    Your portfolio’s asset mix is a key factor in its profitability. Find out how to achieve this delicate balance with a few optimal strategies for asset allocation.
  4. Investing

    Why Asset Allocation Matters in Your Portfolio

    Asset allocation accounts for more than 90% of the investment process.
  5. Investing

    What Is Tactical Asset Allocation?

    Here's how tactical asset allocation, an extension of strategic asset allocation, works.
  6. Investing

    5 Things to Know About Asset Allocation

    Overwhelmed by investment options? Learn how to create an asset allocation strategy that works for you as you build toward retirement.
  7. Financial Advisor

    Which Asset Allocation is Best for Clients?

    Modern Portfolio Theory is showing its age. So which asset allocation model is best?
  8. Managing Wealth

    One Portfolio For Asset Allocation

    If you treat all of your investments as a single portfolio, you will be better able to maximize returns.
  9. Investing

    How to Build Your Optimally-Balanced Portfolio

    How do you build an optimally balanced portfolio? A lot depends on your appetite for risk, and your understanding of rebalancing.
  10. Investing

    The Secret To Consistent Returns In Any Market

    Despite the market’s recent volatility, there are some investors who haven’t seen negative returns. Learn their secret.
Trading Center