What is the purpose of asset allocation in investment strategy?

The purpose of asset allocation in an investment strategy is fundamentally about optimizing the risk/reward profile of an investment portfolio by distributing investments across various asset categories. This strategic distribution means allocating capital among different asset classes—such as stocks, bonds, real estate, and cash equivalents—in a way that aligns with the investor's financial goals, risk tolerance, and investment timeline.

By spreading investments across different asset categories, investors can reduce the overall risk of their portfolio. Different assets often behave differently under various market conditions, so when one asset class may be underperforming, others may be performing well. This balancing act helps to mitigate risk while potentially enhancing returns over the long term.

Concentration in high-performing assets only might lead to significant risks if those assets underperform, while minimizing expenses solely focuses on cost rather than the overall investment strategy. Similarly, diversifying solely in international markets ignores the potential benefits of a well-rounded portfolio that includes domestic assets. Therefore, the correct understanding of asset allocation underscores how it seeks to balance risk and achieve better overall investment performance by leveraging the benefits of multiple asset classes.