Asset allocation is used to describe the make-up of a portfolio, for example a portfolio might have a 40% allocation to stocks, a 40% allocation to bonds, and a 20% allocation to cash. Asset allocation is of vital importance in investing, because it has a material impact on the return and risk profile of the investments. For example a portfolio that has a 100% allocation to equities is likely to show more variance in returns as compared to a fund with a 100% allocation to cash. Asset managers and financial planners will often work with investors or provide tailored products to suit particular investor profiles e.g. higher weightings to higher risk growth assets for young people, and higher weightings to lower risk income assets for people close to or in retirement. Within asset allocation there are further distinctions based on the frequency of the decision, for example strategic or long-term asset allocation aims to find an optimal mix of assets for the risk and reward requirements of the investor. Meanwhile tactical or dynamic asset allocation has a more short to medium term focus which alters the allocation around the benchmark or long term allocation to take advantage of valuation misalignment e.g. if stocks are over valued versus bonds, and so-on.
Synonyms: Optimal portfolio, Dynamic asset allocation, Tactical asset allocation, Portfolio composition, Portfolio construction
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