According to Wikipedia, Asset allocation is a term used to refer to how an investor distributes his investments among various classes of investment vehicles (e.g., stocks and bonds). You may have a lot of cash but you do not know how do you allocate that cash so that you can make money from that invested cash. That is described as asset allocation. According to Investopedia “An investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon” .The three main asset classes – equities, fixed-income, and cash and equivalents – have different levels of risk and return, so each will behave differently over time wealth management.
The cash invested today in the market will yield returns that can have a higher value on returns after a certain period of time. This type of allocation of the funds in the right manner so that you earn a maximum return on investment is termed as asset allocation. Many people will probably give you different options so as to maximize the returns on the investments and that is where the catch is. The catch is that from whom do you take the advice so as to maximize the returns. Probably a stock broker who is dealing in the market on a daily basis as he may suggest you the performance of different funds and securities. Or a bank manager who may tell you to get the money invested in FD’s and bonds. Or a Portfolio Manager who may guide you but may also charge you with huge fees for that. Or rather you can consult your C.A for his suggestions, as he may be the right person who can guide you in terms of the profitability of the fund. The basic objective behind taking up this activity is to allocate fund in the right channel.
There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of individual securities is secondary to the way you allocate your investment in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.
Because the ultimate goal of asset allocation is to create a unique and customized portfolio of assets from the optimal combination of disparate investments, correlations between those asset classes must also be considered when deriving the final weights. These factors measure how diversified the constituent asset classes are and measures how similar asset classes perform over the investment horizon that is under consideration. Investors strive to allocate capital to create a strategic allocation in which each component has a low average correlation to another in the portfolio. There are two types of asset allocation strategies.