Glossary · UK
What is Asset Allocation?
The way an investment portfolio is divided between different asset classes — such as shares, bonds and cash — to balance expected return against the level of risk an investor is prepared to accept.
Full Definition
Asset allocation is the process of dividing an investment portfolio between different broad categories of investment -- most commonly shares (equities), bonds (fixed income), cash, and sometimes property or alternative assets such as commodities -- in proportions chosen to balance the investor's desired level of expected return against how much risk (volatility and potential capital loss) they are able and willing to accept. Because different asset classes tend to behave differently in different economic conditions -- shares have historically offered higher long-term returns but with greater short-term volatility, while bonds and cash are typically more stable but offer lower long-term growth -- combining them in a considered mix aims to smooth out overall portfolio volatility more than holding any single asset class alone, an effect commonly referred to as diversification. A common rule of thumb links asset allocation to an investor's time horizon and risk tolerance: a younger investor saving for retirement decades away might hold a higher proportion in shares to maximise long-term growth potential, while someone approaching retirement, or needing the money sooner, typically shifts toward a higher proportion of bonds and cash to reduce the risk of a sudden market fall depleting funds needed in the near term. Because the relative value of different asset classes drifts over time as markets move, many investors periodically rebalance their portfolio -- selling down asset classes that have grown to be an overweight proportion of the portfolio and buying more of those that have shrunk -- to keep the asset allocation in line with their original target rather than letting it drift passively with market performance.