What is one primary purpose of asset allocation?

The primary purpose of asset allocation is to protect against significant investment losses by diversifying the portfolio. By spreading investments across various asset classes, such as stocks, bonds, and cash equivalents, investors aim to reduce the risk associated with any single investment or sector. This diversification helps to cushion the overall portfolio against volatility because different asset classes often react differently to market conditions. For example, when equity markets may be performing poorly, bonds may still provide stability or even positive returns, thus mitigating losses.

Using a diversified asset allocation strategy allows investors to balance potential risks and rewards according to their financial goals and risk tolerance. This approach is foundational in investment strategy, as it acknowledges that while seeking returns is important, protecting capital is equally critical in achieving long-term financial stability.