Asset allocation describes dividing a portfolio among stocks, bonds, cash, and other asset classes.
The central idea is that different asset classes have different patterns of potential return, volatility, and response to economic conditions. Stocks often provide greater long-term growth potential but can fluctuate substantially. Bonds may provide income and diversification, while cash and cash equivalents generally emphasize liquidity and stability.
An investor’s allocation may reflect time horizon, financial goals, and tolerance for losses. A young investor saving for a distant goal may choose a different mix from someone who expects to spend the money soon. Asset allocation is not the same as diversification: allocation divides money among broad asset classes, while diversification spreads holdings within or across those classes. A portfolio can be allocated across stocks and bonds yet still be poorly diversified if it owns only one company’s shares.