Definition: Asset allocation is an investment plan that attempts to mitigate risk by balancing one’s stock portfolio through diversification and reinvestment.
What Does Asset Allocation Mean?
What is the definition of asset allocation? In laymen’s terms, this refers to the process of carefully weighing out the positives and negatives of certain investments and adjusting investment strategy in such a way that helps grant the highest outcome in one’s portfolio. There are three different types of asset types and they are: equities, fixed-income, and cash and equivalents.
Businesses typically factor asset allocation into their overall investment strategy based on the amount of risk they are willing to incur, their preferred timetable as well as long-term investment goals. They employ several different techniques to maximize asset location ranging from diversification of investments to equitable distribution of resources devoted to equities, fixed-income, and cash investments.
In some cases, businesses employ a holding strategy, which dictates that, the entity hold a stock for a period of a few years or longer. Typically, this is how most investments are made. However, firms seeking a shorter-term return on investment may pursue an alternative strategy that grants returns within a couple of years.
Let’s take a look at an example.
Example
An investor named John has a stock portfolio worth 100 million USD which reflects a near equitable allocation of assets among equities, fixed-income, and cash holdings (33.3%). After a year, John sees that he has made a total of 20 million USD from equities, 10 million from fixed-income investments and another 5 million from cash holdings. John’s total growth after a year would be 35 million, which is a 35 percent increase from the preceding year.
However, John’s portfolio now represents an uneven balance because there is now a greater proportion of his invested assets placed in equities than fixed-income and cash holdings. John compensates for this by taking the excess 35 million USD and reinvesting it in his asset classes in an equitable fashion, in a process called ‘rebalancing’, so that his stocks reflect the same distribution percentage as they originally did (33.3%).
Summary Definition
Define Asset Allocation: Asset allocation means a method of minimizing investment risk through diversification.
