• The theory behind asset allocation is that different investment categories are affected differently by economic events and market factors. Some asset classes move in opposite directions while others move in the same direction at different speeds. By owning different types of assets, it is hoped that when one asset suffers a major decline, other assets will be increasing in value.

• Investments with higher return potential generally have higher risk and more volatility in year-to-year returns. While most investors want higher returns, they may be uncomfortable assuming higher risk levels. Asset allocation allows you to combine more volatile investments with less volatile ones. This combination can help reduce the overall risk in your investment portfolio.

• Not only should you diversify across broad investment categories, such as stocks, bonds, and cash, you should also diversify within those categories. For instance, within the stock category, consider large-capitalization stocks, small-capitalization stocks, value stocks, growth stocks, and international stocks. Bonds could include long-term bonds, intermediate-term bonds, high-quality bonds, lower-quality bonds, Treasury securities, municipal bonds, and international bonds.

• Assessing your risk tolerance is one of the most important, yet most subjective, parts of determining your asset allocation. You are trying to assess your emotional ability to stick with an investment when returns are less than expected.

• Your portfolio can become more aggressive as your time horizon lengthens, since you have more time to overcome downturns in investments. Those with a time horizon of less than five years should not be invested in stocks. Look at cash and bonds for those short-term needs. Individuals with time horizons over five years should consider stocks because of their growth potential. As your time horizon lengthens, you can add higher percentages of stocks to your portfolio.

• Make sure you have reasonable return expectations for various investment categories. Basing your investment program on return estimates that are too high could cause you to increase your portfolio’s risk in an attempt to obtain higher returns.

• In general, consider a more conservative allocation if you are older, have short-term needs for your money, have low earnings, have a low risk tolerance, or are uncomfortable with investing. A more aggressive allocation may be warranted if you have higher earnings, are younger, do not need your money for many years, or are an experienced investor.

• Time diversification is also important. By staying in the market through different market cycles, you reduce the risk of receiving a lower return than expected, especially with investments that fluctuate significantly over the short term.

• Rebalance your portfolio at least annually. Over time, your actual asset allocation will stray from your desired allocation due to varying rates of return on your different investments. Changes may be needed to bring your allocation back in line.

• Be patient. The results of an investment program are best evaluated over a period of years, not days, weeks, or months.