retirement

Asset allocation helps mitigate risk

Here's the ideal scenario: Investors can get rich without taking any risk.

But this is the reality: Investments that potentially offer high returns generally come with high risk -- meaning they can swing both ways, sometimes causing painful losses.

Asset allocation is an investment strategy that can help your portfolio produce optimal returns while mitigating risk. In fact, a famous study done in the 1980s concluded that asset allocation accounts for more than 90 percent of a portfolio's return.

Just as most people would not be well-served with a million-dollar portfolio devoted entirely to one hot stock, it would be an equally imprudent investing strategy to dump everything in short-term Treasuries. Sacrificing return for safety may seem like a good idea -- especially when the market is tanking -- but for long-term investors, it's not.

Instead, diversifying across a broad range of asset classes will help lower risk while providing returns to carry you through your retirement.

Aggressive portfolio
Moderately aggressive portfolio
Moderate portfolio

Don't know an emerging markets fund from a REIT?

Find the descriptions of each individual asset class by rolling your mouse over the slices of these asset allocation charts.

Notice that the aggressive portfolio contains no fixed income (fancy word for bonds). The moderately aggressive portfolio has 16 percent allocated to bonds, while the moderate portfolio has a 40 percent allocation.

Source: Charts are courtesy of Merriman Berkman Next.

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Don't know an emerging markets fund from a REIT?

Find the descriptions of each individual asset class by rolling your mouse over the slices of these asset allocation charts.

Notice that the aggressive portfolio contains no fixed income (fancy word for bonds). The moderately aggressive portfolio has 16 percent allocated to bonds, while the moderate portfolio has a 40 percent allocation.

Source: Charts are courtesy of Merriman Berkman Next.


Don't know an emerging markets fund from a REIT?

Find the descriptions of each individual asset class by rolling your mouse over the slices of these asset allocation charts.

Notice that the aggressive portfolio contains no fixed income (fancy word for bonds). The moderately aggressive portfolio has 16 percent allocated to bonds, while the moderate portfolio has a 40 percent allocation.

Source: Charts are courtesy of Merriman Berkman Next.



Portfolio theory
Asset allocation is the art of purposefully building a portfolio made up of different kinds of investments that are not correlated to one another.

"Asset allocation comes out of portfolio theory. It is the end result," says William Bernstein, author of "The Intelligent Asset Allocator" and "The Four Pillars of Investing: Lessons for Building a Winning Portfolio."

Portfolio theory quantifies how investors can put together a portfolio of non-correlated assets for a given return at a given rate of risk.

It's heavy on math and chockfull of numbers and squiggly Greek symbols, so really getting into the nitty-gritty of it takes some dedicated effort. Sophisticated investors can calculate their level of risk and expected returns based on statistics and historical data.

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