Asset allocation refers to an investment strategy in which individuals divide their investment portfolios between different diverse asset classes to minimize investment risks. The asset classes fall into three broad categories: equities, fixed-income, and cash and equivalents. Anything outside these three categories is often referred to as alternative assets.

For example:

Let’s say Mr. X is in the process of creating a financial plan for his retirement. Therefore, he wants to invest his $10,000 saving for a time horizon of five years. So, his financial advisor may advise Joe to diversify his portfolio across the three major categories at a mix of 50/40/10 among stocks, bonds, and cash. 

The distribution of his investment across the three broad categories, therefore, may look like this: $5,000/$4,000/$1,000.

Financial advisors usually advise that to reduce the level of volatility of portfolios, investors must diversify their investment into various asset classes. Such basic reasoning is what makes asset allocation popular in portfolio management because different asset classes will always provide different returns. Thus, investors will receive a shield to guard against the deterioration of their investments.