Asset allocation is an investment portfolio technique that aims to balance risk by dividing assets among major categories such as cash, bonds, stocks, real estate, and derivatives. Each asset class has different levels of return and risk, so each will behave differently over time.

For instance, while one asset category increases in value, another may decrease or may not increase as much. Some critics see this balance as a recipe for mediocre returns, but for most investors, it's the best protection against a major loss should things ever go amiss in one investment class or sub-class.

The consensus among most financial professionals is that asset allocation is one of the most important decisions investors make. In other words, your selection of stocks or bonds is secondary to the way you allocate your assets to high and low-risk stocks, to short and long-term bonds, and to cash.

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