Not every egg in a single nest:decide how much in each shall rest.
The strategy of distributing investments across various asset classes, such as currencies, equities and commodities, to balance risk and reward according to a trader’s goals and risk tolerance.
In plain words
Asset allocation is the decision about how to divide money between different kinds of asset, such as shares, bonds, commodities, currencies and cash. The idea behind it is that different kinds of asset do not all rise and fall together, so the mix shapes how much the whole portfolio swings.
See it move
Shares: the largest here
Why it matters
The split between kinds of asset is commonly said to explain much of how a portfolio behaves, more than the choice of individual instruments within each kind. A trader whose positions are all in one market has, in effect, allocated everything to it.
Worked example
An example only. The figures are round and invented for the arithmetic: they are not market prices.
A portfolio of 10,000 is split 50% shares, 30% bonds and 20% commodities, and over an invented year shares lose 10%, bonds gain 2% and commodities gain 5%.
- 1Shares5,000 × −10% = −500
- 2Bonds3,000 × 2% = +60
- 3Commodities2,000 × 5% = +100
- 4Total = −500 + 60 + 100 = −340
The portfolio falls by 340, or 3.4%, compared with 10% had it all been in shares.
A common mistake
Spreading money across assets does not remove risk. In periods of market stress, assets that usually move separately can fall together.
Check yourself
Educational information, not investment advice or a recommendation to trade.