The power of asset allocation comes from reducing risk while increasing returns. Reducing risk by combining multiple asset classes, however, is not a simple process. While each asset has its own unique measure of risk, many assets share similar price behavior (their prices go up and down together in any market). Combining such complimentary investments increase the risk of wild changes in price. Trade-offs between asset risk and expected return must also be considered. High yield assets typically experience high volatility, or large changes in price. These assets must be balanced by investments with lower rates of return to protect against large declines in value.

Successful asset allocation requires finding the proper mix of assets to balance reward with an acceptable level of risk. Proper allocation planning requires asset research and investment analysis. Fortunately, tools are available to assist the independent investor. Popular financial websites offers independent investors help with educational links and software to build portfolio allocations based on a survey of financial questions. For advanced investors, many books have been written to painstakingly explain the theory and practice of asset allocation ? also called MPT (Modern Portfolio Theory). Casual investors can purchase mutual funds specifically designed to automate asset allocation based on an expected retirement date. Pragmatic investors can explore the many financial planners and advisory services that offer asset allocation portfolios specific to their needs.

Consider your options carefully. Each solution offers its own set of advantages and disadvantages. Pick a style that closely reflects your own. Just how important is asset allocation? It's the single largest determinant of your long-term financial success.

Tim Olson

Mr. Olson is the editor of The Asset Advisor, a financial investment service providing proven strategies for no-load mutual fund investors. He brings 26 years of education and experience from Stanford University, Ernst & Young, personal wealth management, and venture capital investing.