What does the term "asset allocation" refer to?

The term "asset allocation" refers specifically to the process of dividing an investment portfolio among various asset categories, such as stocks, bonds, and cash. This approach is fundamental in portfolio management, as it helps investors balance risk and return according to their individual risk tolerance, investment goals, and time horizon. By spreading investments across different asset classes, an investor can potentially mitigate risk because various assets often respond differently to market conditions. For instance, when stock prices fall, bond prices may hold steady or even increase, helping to cushion the overall portfolio from significant losses.

While timing the market for maximum investment gain, comparing fund performance to market trends, and focusing solely on low-risk assets can all play a role in an investment strategy, they do not capture the essence of asset allocation, which is primarily concerned with how and where to distribute investments across various types of assets to optimize potential returns while managing risk.