Allocate Your Assets Like a Pro

While you may understand that diversification involves investing across different industries and businesses (see Industries vs. Sectors: What's the Difference?), you might not realize how important it is to look at your investment portfolio in terms of asset class as well.

Asset allocation is a major strategy used by fund managers (see portfolio manager ) to meet the investment goals of fund investors. Basically, managers look at how the value of a portfolio of investments is divided among the three main asset classes (equity, fixed-income and cash). So how can you use that strategy in your own portfolio?

Aim, Then Allocate

With asset allocation, it's all about goal-oriented investing. Whose goal? Yours.

Since each asset class has different characteristics, the way you split your portfolio between equity, fixed income and cash can have a direct effect on whether or not you'll be able to finance your goal.

So the first criterion for determining whether asset allocation should be put to use in your personal portfolio is your end goal. For example, if you're a daytrader (see "So You Want to Daytrade"), you're probably going to have very different goals from someone who's primarily investing for retirement (see IRA and IRA-related stories on TheStreet.com). For individual investors, asset allocation can really help those who are investing for a high-cost, long-term goal such as retirement or a college fund.

Three Classes for the Long Road

There are three main asset classes: equity (stocks), fixed-income (bonds) and cash (money markets). The markets for each of these behave very differently from one another, so here's a look at each one: