The point of asset allocation is really diversification. The ideal would be to make sure there is little correlation between the assets that you hold and invest in.
For example, if you find a bunch of good stocks to invest in within the energy sector, you are really not diversified. It doesn’t matter if you have a hundred energy stocks in your portfolio. They will all be pretty closely correlated.
If you want true diversification, you have to do asset allocation. There’s really no way around it. You have to be in multiple financial markets.
So asset classes are things like stocks, bonds and derivatives. They are basically categories of securities. You can also include cash, money market funds, and Treasury bills in this as well.
If you want to diversify properly, you have to have some mix of asset allocation in your portfolio. Now most people are just in stocks and bonds. That seems to be adequate in most cases.
What many financial advisers recommend is 80% in stocks and 20% in bonds when you’re first starting out. Then as you get older the recommendation is to shift more toward bonds.
Many retirees end up with 10% stocks, usually dividend stocks, and 90% bonds. That is because when you need the money in the short term, you may not have time to ride out the inevitable volatility that comes with being in the stock market. It’s just how it is. So advisers will recommend that you not put money you need in the next 5-8 years to be in the equity market.
Of course, all of this is subject to review and a personal consultation by your investment adviser. Not all asset allocation strategies are right for everyone. You need to get an adviser or financial planner to help you with this kind of stuff.
Asset Allocation For Dummies