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Asset Allocation vs. Diversification: What’s the Difference?

businessman hand stacking coins for finance investment management by portfolio diversification for distributing risks and increasing opportunities

You’ll see them from time to time—perhaps in financial news reports or tucked in corporate statements. At first, they may appear to be interchangeable, but in reality, they couldn’t be more different. But they do share one thing in common: Both are designed to help an investor manage risk during periods of market volatility.

“A wise man will hear, and will increase learning, and a man of understanding shall attain unto wise counsels.” Proverbs 1:5

We’re talking about asset allocation and diversification. Here’s a closer look at how both strategies can play a role in portfolio management.

Asset Allocation

Asset allocation is the process of dividing your investment dollars among asset classes, such as stocks, bonds, and cash. Your goals, time horizon, and risk tolerance are three factors that help guide your asset allocation strategy.

With asset allocation, one factor to consider is that market fluctuations can cause the weighting of asset classes to change over time. For example, in 2023, the Standard & Poor’s 500 stock index gained more than 24%, which may have affected the stock portion of some asset allocation strategies.1,2

Case Study

Whether you know it or not, you’ve allocated your assets. If you own a retirement plan, a home, or a shoebox of money stuffed under your bed, you’ve allocated your assets among different asset classes. When we work with clients, we help them see their current asset allocation and show them the value of making “intentional decisions” regarding asset allocation.

When we review a portfolio, we determine if adjustments are needed based on market performance —or other non-market factors— because we know that your investment goals evolve over time due to life changes. Your asset allocation needs to be flexible enough to adjust as your personal situation evolves.

“Never invest just to invest! Only invest to achieve something—a goal or to meet a need,” explained Mick Owens, who wrote the popular book Diamond of Life: The Five P’s of Success and Significance.

Diversification

Diversification is the process of spreading your investment dollars within or across a certain asset class. For example, an investor may be able to diversify within a stock asset class by holding a tech company, a drug company, and a retailer.

One of the goals of diversification is to identify the correlation between assets or asset classes. Investments with a low correlation tend to move more independently, while investments with a high correlation may move in a similar direction. Diversification can help manage a portfolio’s risk profile by holding assets with a low or negative correlation.

With diversification, investment approaches can range from conservative, which may focus on capital preservation and generating income, to aggressive, which might accept higher volatility for potential returns. Just like asset allocation, your goals, time horizon, and risk tolerance will help guide your approach.

The Bottom Line

Whether you’re saving for retirement, creating a retirement-income strategy, or helping pay for college expenses, asset allocation and diversification can play a role in how we pursue your investing goals. By using these principles, we can help build a portfolio that supports your overall objectives.

  1. Finance.Yahoo.com, December 31, 2023. Stocks are represented by the S&P 500 Composite Index, an unmanaged index that is considered representative of the overall U.S. stock market. Past performance does not guarantee future results. Individuals cannot invest directly in an index. The return and principal value of stock prices will fluctuate as market conditions change. Shares may be worth more or less than their original cost when sold.

  2. The market value of a bond will fluctuate with changes in interest rates. As rates rise, the value of any existing bond typically falls. If an investor sells a bond before maturity, the bond may be worth more or less than the initial purchase price. By holding a bond to maturity, an investor will receive the interest payments due plus the original principal, barring default by the issuer.

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