CRPC question Asset allocation is best defined as a(n)
A) method of investing funds among a number of different asset classes, with the intent of reducing the effect of market fluctuations.
B) investment strategy that attempts to find and purchase shares of companies whose sales and profits are expanding faster than those of the economy.
C) investment strategy that seeks to buy asset classes that are undervalued and sell those that have become overpriced.
D) investment strategy that allocates portfolio asset classes from one category to another in anticipation of broadly based economic growth.
The correct answer and explanation is:
The correct answer is A) method of investing funds among a number of different asset classes, with the intent of reducing the effect of market fluctuations.
Asset allocation refers to the practice of distributing investments across various asset classes, such as stocks, bonds, real estate, and cash equivalents. The primary goal of asset allocation is to reduce the overall risk of the portfolio by spreading investments among different asset categories that may respond differently to market conditions. By diversifying in this way, the risk associated with a single asset class is minimized, making the portfolio more resilient to market fluctuations.
Each asset class has its own risk and return characteristics. For example, stocks tend to offer higher potential returns but are also more volatile, while bonds typically offer lower returns with more stability. By balancing the portfolio between these classes, an investor can create a mix that aligns with their risk tolerance and investment goals. The process of asset allocation is important because it allows investors to take advantage of the different performance cycles of asset classes. When one asset class is underperforming, others may be performing better, thus stabilizing the portfolio’s overall performance.
There are different methods of asset allocation, such as strategic, tactical, and dynamic. Strategic asset allocation involves setting a long-term allocation based on the investor’s risk profile and financial goals. Tactical asset allocation allows for short-term adjustments based on market conditions, while dynamic asset allocation involves continuous adjustments in response to changes in the market or economy.
In contrast, options B, C, and D refer to specific types of investment strategies rather than a general approach to managing a portfolio through diversification across asset classes.