Diversification and active asset allocation – not the same

Diversification refers to how an investment portfolio is divided into various asset classes such as stocks, bonds, and cash. Since different asset classes rarely perform in lockstep, the goal of diversification is to reduce investment risk since positive returns from one asset class can be used to offset the returns from another that’s underperforming.

Active asset allocation takes diversification a step further. By determining which combination of assets can provide the highest return potential for a certain level of risk, it attempts to forecast the performance potential of a portfolio and reduce the chance of negative returns. Ongoing monitoring helps ensure the portfolio’s asset mix can adapt quickly to take advantage of changes in the financial markets. Active asset allocation is the same approach taken by large financial institutions and pension plans and is considered a best practice for wealth management.

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