6 asset allocation strategies to help diversify your portfolio

You've probably heard the saying about not putting all your eggs in one basket. This adage rings especially true when you're investing to reach long-term or specific financial goals for your family.

It can be risky to go all-in on a single asset or even limit yourself to a narrow slice of the investment universe. If those holdings lose value, your portfolio could go along for the ride. But spreading out your money across investments can reduce the chances of major losses. Matching your goals to an asset allocation strategy can help you do just that.

Asset allocation is the practice of thoughtfully diversifying your holdings—or investing in a variety of assets—to manage risk while pursuing growth.

The markets and the economy often affect your investments, but certain investments respond in different ways. For instance, when the economy shows signs of softening, some stocks might fall due to fears of lower earnings. Meanwhile, government bonds might hold steady or even gain value as people look for safety. Sometimes, company news can affect stock and bond prices, leading to gains and losses unrelated to broader economic conditions.

By holding various investments, gains in some of your holdings might offset losses in others. As a result, you could have a less volatile investing experience overall.

When you're considering which assets to allocate across your portfolio, you're usually looking at three broad asset classes:

Otherwise known as stocks or equity investments, equities represent a stake of ownership in a company. When a company's stocks appreciate in value or when they offer a dividend, your investment grows. These assets offer the potential for growth, but they can be relatively risky and may experience large losses.

With a fixed-income asset, you're essentially entering into a loan with a company or government entity. You lend the issuer money, and in exchange, you receive interest payments over a fixed period of time. This asset class is most commonly referring to bonds. These assets tend to be more stable and pay income, and they can act as a stabilizer during volatile times. But bonds also can lose money due to economic conditions or issuer-specific events.

Cash and its equivalents—CDs, money market funds, Treasury bills and notes, and commercial paper—are the most liquid form of investments in your portfolio. This means you can access them more readily than bonds or stocks. Cash can be a safe asset class for the most conservative investors, but it might lose purchasing power over time due to inflation.

It's natural to question whether diversification is always the best course. The idea behind diversifying is that you don't risk significant exposure to a single sector or holding that may not pan out. You're aiming to have some investments that perform well to balance out any that don't.

But if you think you can predict which investments might outperform others, you might prefer not to diversify and instead concentrate holdings in those areas. That approach can work well if you're right, but timing the market can more often be problematic if things don't go as expected.

Either way, while diversification can help reduce market risk, it doesn't eliminate it, nor does it assure a profit or protect against loss in a declining market. As with most financial decisions, your approach depends on your situation, expertise and risk comfort level.

Consider your financial goals as you look to find the right blend of assets. Your portfolio may look different depending on the results you're hoping to see, over the short term, long term or a mix of both. Generally, most portfolios tend to follow one of three asset allocation models:

Growth-based portfolios have a heavier exposure to stocks to maximize potential returns. A portfolio with at least 70% stock holdings represents an aggressive, growth-oriented allocation.

In general, a growth-based portfolio makes the most sense if you have a longer time horizon and can afford to take on greater short-term risk. If you're saving for a retirement that's several years away or putting money into a college fund for a young child, for example, maximizing returns is likely your primary objective.

A balanced investment strategy tries to find the sweet spot between growth potential and asset preservation. A roughly even blend of stocks and bonds, such as a 60/40 asset mix, represents a balanced portfolio.

This approach is often suited to investors approaching retirement age, who may need to tap their investment assets in a few years. Even in retirement, having some exposure to stocks may be necessary so your assets last.

An income-based portfolio could include steady, dividend-paying stocks or high-quality bonds that make regular interest payments. Income-based portfolios allocate 70% or more of their assets to bonds and other fixed-income securities.

This strategy can be best for more conservative investors or those getting deeper into their retirement, as it offers lower volatility and can provide a stream of income.

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Weighing risk vs reward

Risk and reward often go hand in hand, especially when it comes to investing. The thought of growing your wealth can be exciting, but more risk could result in a higher chance of loss. Read more about how to understand your risk tolerance so you can make decisions you're comfortable with.

Dive deeper

With your style of investment portfolio in mind, you can dive deeper to land on the specific asset allocation strategy for building and managing your portfolio over time. Your strategy can reflect how much risk you're able to take, ranging from aggressive to conservative to somewhere in between.

Consider these six common approaches to asset allocation:

Strategic asset allocation is a long-term investing approach that typically stays the course regardless of market events. Over time, you might adjust the holdings to reflect changes in your life—for example, if you prefer to get slightly more conservative each year.

But you're generally not trying to change course dramatically or move to the sidelines temporarily in response to market movements. You may need to rebalance the portfolio periodically to maintain your desired allocations.

The constant-weighting approach seeks to maintain a consistent proportion of stocks, bonds and other asset types over time through rebalancing. For an asset allocation example, imagine you start with a portfolio of 70% stocks and 30% bonds. If the market is hot and causes your stock holdings to appreciate faster than your bonds, you may find that 80% of your portfolio is now devoted to stocks. To achieve constant-weighting asset allocation, you might sell some of your stocks and buy more bonds. In doing so, you maintain an appropriate risk level, regardless of what the market does.

You can rebalance your portfolio manually, either at specific time intervals or when your asset allocation shifts by a certain percentage. Alternatively, you can have a financial advisor manage your asset mix for you, although these accounts typically involve additional fees.

Tactical asset allocation is a more active strategy that may involve frequent changes to your holdings. Hypothetically, when you expect markets to perform well, you might add exposure to stocks or certain sectors. But if you think markets might fall, you might shift funds to cash or bonds.

The success of this strategy depends on your ability to anticipate market movements, which is a difficult task—even for professional fund managers. Because tactical allocation is riskier and involves more transaction fees, it should be approached with caution.

An asset allocation strategy doesn't have to be an all-or-nothing proposition. As with the tactical approach, an integrated model seeks to anticipate movement in the market to maximize returns. However, it also incorporates an understanding of your overall risk tolerance. Therefore, if you're nearing retirement and seek a balanced portfolio, you wouldn't go all-in on stocks, even if you anticipate a bull market in the months ahead. Instead, you may seek smaller changes or shift into different types of stocks that are expected to perform well in the short term.

While an integrated approach is generally less risky than a tactical strategy, it has the same basic flaw. Historically, most investors have found it difficult to beat the market. Trying to predict how securities might move in the short term may add unnecessary fees and leave you with a portfolio too heavily weighted toward a particular sector or part of the world.

An insured asset allocation strategy typically attempts to maximize returns through active portfolio management but adds a safety mechanism. If your portfolio falls below a certain "floor" value, you purchase lower-risk assets to avoid further losses.

While the idea of minimizing risk is an attractive one, these interventions can do unexpected long-term harm. Asset classes that take a temporary hit are often the fastest ones to bounce back when market conditions change. By selling off assets when they're down, you may handicap your ability to get back to where you were—or even higher.

Dynamic asset allocation is another active way to manage your portfolio. Rather than trying to guess what the market might do, however, a dynamic allocation seeks to purchase securities that are undervalued by historical standards (and vice versa). The central premise is that, over the long run, an asset or asset class selling at an attractive price tends to rise faster than those selling at higher valuations.

Several companies offer mutual funds that utilize this approach. Because they're actively managed, they tend to impose higher fees than passively traded funds, which can weigh down performance. If you're considering a dynamic fund, review the typical asset mix with the fund to understand how it may fit into your portfolio.

At the end of the day, your ideal asset allocation depends on your unique goals and situation in life. To find out which asset allocation strategies are best for you, speak with a financial advisor who can help design a portfolio tailored to your specific needs.