Asset allocation is a technique used in investing where investors deposit money in multiple investments.  Each investment having a certain percentage or allocation of the money.

For example, you might have 4 mutual funds that you invest in:

• A Large Cap Fund
• A Mid Cap Fund
• A Small Cap Fund
• A International Fund

Each having a certain percaentage of the money deposited every month.

The total is always equal to 100%.  So lets say you want most of your money in the parge cap fund.  You would then allocate 50% of your funds to the large cap fund.  Next you would want your next largest position with the mid cap fund.  You would then allocate 25% of you money to it.  Then you would want you next position to be int he small cap fund so you would allocate 15% to it.  Finally we would have the international fund in which we would allocate the rest of the money which would be 10%. 

50%+25%+15%+10%=100%

Now after you have your asset allocation set you wil have to periodically (either anually or semi-anually) adjust the balances to the original percentages.

Asset Allocation Example:

You start off with $100 and with the asset allocation we described above you would allocate as follows:

• Large Cap Fund - 50% - $50.00
• Mid Cap Fund - 25% - $25.00
• Small Cap Fund - 15% - $15.00
• International Fund - 10% - $10.00

Re-Balancing:

At least once or twice a year you have to re-balance your money so you can keep your asset allocation at the percentages that you want.

Example: After 1 Year

Large Cap is at $97

Mid Cap is at $23

Small Cap is at $56

Int'l is at $27

So the total for all 4 funds is $203 so now we have to rebalance the mutual funds to the correct percentages.

How is that done?  Well all you do is add up the balances for all 4 funds and then multiply it by the allocation percentage.  Here is how we do it for the example above.

Large cap is $203 x 50% = $101.50 so the new balance for the fund is $101.50 now the fund is at $97 right now so we have to add $4.50 to the fund. Which means buy more shares.

Mid cap is $203 x 25% = $50.75.  the balance for the fund right now is at $23 so we have to add $27.75 to the mutual fund. Which means to buy more shares

Small cap is $203 x 15% = $30.45. The fund is at $56 so that means we have to take out money from this fund. We need to take out $25.55.  Now this $25.55 can go into the other funds that need the money to get to the percentage we set.  Which means we need to sell shares

Int'l fund is $203 x 10% = $20.30.  The fund is at $27 so we need to take out $6.70 and allocate that where we need it.  Which means we need to sell shares.

• Asset Allocation (AA) is the investing process where the investor periodically adjusts balances between accounts to maintain a consistent percentage of the whole in each account
• AA forces you to buy low sell high which ensures profit taking
• AA automatically buys below the average share price
• AA has all the same benefits of dollar cost averaging except it requires a bit more effort each period
• AA is considered less risky than dollar cost averaging