A bull market can leave many investors feeling pretty good about their ability to prosper. Extraordinary performance, however, can create a false sense of security. As a result, many investors can make mistakes such as overdosing on equities, concentrating too heavily in one particular stock, picking stocks on their own, trying to time the market, failing to rebalance their portfolios, investing short-term money in stocks, or basing their investment goals on unrealistic market assumptions. Basically, asset allocation means not putting all of your financial eggs in the same basket.
Asset allocation is important because it helps balance risk and reward.
In general, the greater the investment risk, the higher the potential for increased total returns. By spreading your holdings among different asset classes, you help balance risk with reward. Assessing your goals, your timeframe, and your risk tolerance are critical in determining what types of assets to purchase, and in what proportion. Once an appropriate asset allocation has been determined, diversification within those asset classes is necessary to achieve an effective, well-rounded investment strategy and to reduce risk. If you hold only one large investment, your portfolio may become lopsided, and generate poor long-term results.