How to Allocate Assets Asset allocation refers to choosing asset classes a person will invest in. What makes asset allocation particularly important is the fact that it is directly linked to the success or failure of one's investment portfolio. In other words, those of you who have a clearer and better understanding of how asset allocation works are bound to make wiser and more profitable investments and thus increase their net worth in the long run. What is asset allocation? By definition, asset allocation is a process whereby an investor diversifies his or her portfolio with different classes of assets. These can be stocks of different companies, bonds, state securities, cash investments and foreign currency, real estate, collectibles, precious metals, natural resources, and life settlements. In view of size, assets can be divided into large-, mid-, and small-cap, with investors focusing on value, growth, and blend. Each investor may adopt a different asset allocation strategy, depending mostly on his or her investment goals and level of risk tolerance. Investors vary in their preferences and styles: some opt for short term trading while other choose long term holding. Some of the investors prefer to invest in one asset class, others – in a portfolio of assets. Some individuals make use of derivatives while others do not. Because the markets are constantly changing, due to the unstable global economic climate, investors should examine and, if necessary, reconsider or rebalance their asset allocation strategy at least once a year. In addition, one's asset allocation plan may change throughout his or her life as a result of, say, retirement or unexpected deterioration of their financial situation. Below are the steps one has to take in order to adopt an adequate and efficient asset allocation strategy. As a first step, you have to figure out how much money you can afford to spend as to diversify your investment portfolio and how much money you can continue to add up to your diversified portfolio. Step two involves deciding on your time horizon. You can adopt a short-term asset allocation strategy and use the yields to buy a new home or choose a long-term one and use the profit after your retirement. The third step is to determine your personal level of risk tolerance. You can do it by filling in one of the numerous risk-tolerance questionnaires available over the Internet, or take one from your investment advisor. Basically, risk tolerance is your ability to deal with possible slumps in the value of your investment portfolio. Thus, if you have a low level of risk tolerance, your investment advisor will recommend you some secure, low-to-medium-yield instruments such as cash investments, while people with higher level of risk tolerance may opt for riskier but more profitable investment solutions such as stocks. Having determined your level of tolerance and time-horizon, you should now pick up a diversified and well-balanced portfolio of investment instruments such as stocks, bonds or cash investments. Keep in mind that risk tolerance is hard to measure before you have invested money in a real bear market. Finally, do not forget to revise your asset allocation strategy, if your life situation or investment preferences change over time.