When it comes to personal finances and investments, there are many things that we need to consider. Naturally there is the personal budget and seeing our outgoing expenses. Debt should also be taken into account and hopefully avoided whenever possible. Insurance, child expenses, taxes, and planning for the future are other areas of personal finance concern.

However, one area that seems to unnecessarily confuse some personal investors is asset allocation. This is the idea of ​​dividing your investments in such a way that you take advantage of the diversity of the different asset classes. Stocks, bonds, real estate, cash and commodities are just a few examples of the asset classes available to us as individual investors. Research has shown that asset allocation may be the most important investment decision, but how do you determine the best way to allocate your limited assets in a seemingly limitless investment field?

One thing to keep in mind is that the asset allocation research was actually done using data from institutional investment accounts. Because the vast majority of individual investors do not have enough capital to adequately diversify across all major asset classes, this research is not as relevant to the individual as one might hope. However, we can still take advantage of research using investment vehicles like mutual funds and exchange-traded funds (ETFs).

The advantage of these investments for the individual investor is that they diversify their assets and allow for smaller investment amounts. For example, an investor with only $50k in assets would be hard-pressed to develop a sufficiently diversified stock portfolio. This doesn’t even take into account all the other possible asset classes that can provide protection when share prices are falling.

Using ETFs, for example, an individual investor could spread their money across a variety of asset classes. There are often correlations between asset classes that provide protection against the volatility inherent in the markets. When stocks fall, bonds tend to rise. When bonds are falling, commodities may be rising. If commodities are down, real estate could be up. By spreading your risk across the various asset classes, you may limit your upside potential somewhat, but you are also reducing the volatility of your portfolio, allowing for a much smoother rise in your assets.

While this article has just touched on the importance of asset allocation for personal finance and investing, I think you get the gist. To learn more about the art of asset allocation, you should visit the amateurassetallocator.com website where you can get more detailed information on various asset classes and how diversification can protect your portfolio.