In investment strategy, asset allocation refers to choosing how much of your portfolio to dedicate to different asset classes. Asset allocation must be customized for the individual investor, and will depend on one’s goals, risk tolerance and time horizon. The way assets are distributed is considered one of the key aspects to successful investing and financial planning. It is generally a good idea to have a mixed portfolio with different types of assets.
The three main recognized types of assets are stocks (or equities), bonds (fixed income assets), and cash. Cash includes cash equivalents such as certificates of deposit. Real estate is also sometimes considered to be a fourth category. Each type of asset is associated with different levels of risk and time frame. In general, stocks are better for long-term investments (of five years or more) since a longer time frame allows an investor to ride out short-term fluctuations in the market and gain potentially higher rewards. Cash and money market accounts are good for short-term goals a year or less away, such as a vacation or a new car. Bonds, which usually have slower growth than stocks, generally fall somewhere in between. Risk tolerance also plays an important role in deciding asset allocation: a person may decide to put more money in bonds than in stocks because they are risk adverse and do not want to worry about losing money in the market.