Understanding asset allocation and diversification

Asset allocation and diversification can help you strike the right balance between risk and return in your portfolio. Holding a broad range of investments can help lessen the impact that any one economic or market event will have on your portfolio. That’s because different investments gain or lose value at different rates and at different times.

A healthy mix

Asset allocation refers to the different weightings of stocks, bonds and cash in your portfolio. Because these three asset classes have tended to have varying rates of return and risk profiles, asset allocation plays a role in helping you achieve your investment goal.

Diversification takes this process one step further by spreading your money across different investments within the same asset class. Rather than trying to figure out which type of stock or bond will perform best, you would invest in many types. Over time, the ups of one investment have the potential to balance out the downs of another, with the goal of reducing the risk level in your portfolio.

Here’s how asset allocation and diversification shape a portfolio.

Here’s how asset allocation and diversification can shape a portfolio

The pie charts depict two portfolio asset allocation strategies. The chart to the left displays a portfolio allocated across three main asset classes: stocks, bonds and cash. The chart to the left displays more than half of the portfolio allocated to stocks, the second highest allocation to bonds and the least allocation to cash.

Across asset classes

This portfolio is allocated across the three main asset classes. Your asset allocation will depend on your investment goal, time horizon and risk tolerance.

The chart to the right displays the same portfolio allocated across the same three main asset classes and equally breaks down the stocks asset class allocation into four categories: U.S. large cap, international, U.S. small cap and emerging markets.

Within an asset class

While stocks still have the same percentage allocation, this shows how stocks are now diversified across investments that vary by size and geography.

Allocations shown for hypothetical purposes only. Financial professionals should tailor portfolios according to the needs of investors.

Spread out your money

Asset allocation can have a big impact on your portfolio’s rate of return. In general, stocks are riskier than bonds, though most investors may need both. Your investment goal, risk tolerance and time horizon help determine the best asset class mix for you.

Because the asset classes don’t typically grow at the same rate, you’ll need to periodically rebalance your portfolio. Rebalancing helps maintain your intended asset allocation. Many investment firms offer the option of signing up for automatic rebalancing.

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Fine-tuning your portfolio

It’s hard to diversify by geography, size and industry using individual investments. That’s why so many investors rely on mutual funds. It would take a lot of time and resources to construct a portfolio similar to a mutual fund’s.

A typical stock fund holds 75 to 100+ different investments. And the investment minimum for most bond mutual funds is usually less than what you’d need to purchase a single bond.

Investments are not FDIC-insured, nor are they deposits of or guaranteed by a bank or any other entity, so they may lose value.

Investors should carefully consider investment objectives, risks, charges and expenses. This and other important information is contained in the fund prospectuses and summary prospectuses, which can be obtained from a financial professional and should be read carefully before investing.

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American Funds Distributors, Inc.

This content, developed by Capital Group, home of American Funds, should not be used as a primary basis for investment decisions and is not intended to serve as impartial investment or fiduciary advice.

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Getting started

Asset allocation and diversification

A mix of investments is typically better than one

A healthy mix

Here’s how asset allocation and diversification shape a portfolio.

Here’s how asset allocation and diversification can shape a portfolio

Spread out your money

Fine-tuning your portfolio

Learn more about investing