These risks can be minimized by creating a portfolio of different investments that tend to react differently to the various types of risk. When developing an allocation strategy, the asset mix is matched to the investor's objectives, time horizon, and risk tolerance. The following chart illustrates the historical risk and return associated with different mixes of bond and stock investments. The expectation of asset allocation is that all investments in the portfolio will not produce high returns, but losses in one class will be offset by gains in others. The goal of asset allocation is to maximize potential return based on the investor's acceptable level of risk.
Investors can achieve diversification with mutual funds.
These funds invest in different asset classes. An investment in one type of mutual fund will expose the investor to the risk of that asset class. It is becoming more difficult to select mutual funds that satisfy the investor's risk tolerance, investment time horizon, and desired rate of return. Currently, there are more than 8,400 mutual funds for investors to choose from, and the number is growing. In 1972, there were only eight bond mutual funds, compared to approximately 3,000 today.