Have you ever noticed? What’s clear to an “insider” isn’t always so obvious to everyone else. Doctors, lawyers, engineers … investment advisors. I’m afraid we’ve all been guilty of tossing around too many technical terms without defining them first.

Take “asset allocation,” for example. It’s so central to what I do every day as a portfolio manager, sometimes I forget: If you’ve never heard it before, you may not know what it means, or why you should even care about it to begin with.

Today, let’s demystify this important investment term, using an analogy from one of my favorite summer sports. That’s golf!

Asset Allocation Is a Mixed Bag

What if, as a golfer, you had to play each course with just one club? My putter is great for when I’m already on the green. But, I certainly wouldn’t want to have to tee off with it. Likewise, I’m sure my driver would drive me nuts if I were trying to sink that final tap (or two) into the hole.

By starting with a great mix of quality clubs, I figure I’m best equipped for my time on the course. Whether I end up in a sand trap or have just made that almost hole in one, I can always make the most of my next swing by having various clubs to choose from.

Now, translate these same concepts to your investment portfolio. Asset allocation is like having that great, mixed bag of clubs to help you stay the course during your entire investment game.

Going the Distance with Asset Classes

The “assets” part of asset allocation are like the different kinds of clubs in your bag. Through the decades, financial economists have studied the course, so to speak, and identified how different sources of investment returns are expected to behave under different market conditions.

We use their body of work to categorize similar sources of returns into asset classes. So, for example, stocks are one broad asset class. Bonds are another.

Within each of these broad asset classes, we’ve also defined distinct subsets, like variations on a common theme. Within stocks, you’ll find small-company versus large-company stocks. There’s also value versus growth stocks … i.e., companies that are a little stressed versus those big, booming ones. There also are Canadian versus international stocks.

In bonds, you’ll find domestic and international subsets based on the bond’s term: Will the bond come due in the near-term, or a decade from now? There’s also credit risk, or how likely it is the bond lender might default on their obligation to you.

Beyond stocks and bonds, there also are a few specialized asset classes, such as real estate and emerging markets, with similar subsets of their own.

So … taken as a whole, the subsets found within each broad asset class share some common elements. A stock is a stock; a bond is a bond. But within each asset class there are distinct qualities that are expected to contribute to your overall game. It’s like having several different kinds of drivers and woods, plus a few specialized clubs. Taken as a whole, you’re better set to manage the many conditions you may encounter as you make your way from tee-off to final putt.

Adding in Appropriate Allocations

Once you’ve identified which asset classes you want to hold in your portfolio, the next logical question is: How much of each? That’s your asset allocation.

At the highest level, you typically allocate your total portfolio into “X” percent of stocks and “Y” percent of bonds. If you recall from past “No Dumb Questions,” stocks are expected to deliver higher returns over time. But they also tend to do so in fits and starts. Bonds deliver lower expected returns, but more consistently. That’s one reason we allocate between them. A well-built portfolio also includes allocations to those subsets found within each broad category.

Let me emphasize, the specific allocations that make the most sense for you and your goals will vary. Again, my golfing-foo should come in handy here. Anyone who heads out on the links is advised to carry a similar mix of clubs … because golf is golf. But how often will you use each club? How many swings will you “allocate” to each one? That will vary, based on the course you’re playing, as well as your individual strengths, weaknesses and personal preferences.

Similarly, almost every investor is well served by building and maintaining a broad, globally diversified portfolio based on evidence-based asset allocations. But your portfolio’s precise mix can and should vary based on your unique circumstances. This is also why it’s important to not spend too much time comparing your portfolio’s performance to others. As I covered in my past “No Dumb Question” on investment envy, they may be playing a very different game from you, on an entirely different “course.”

Are you getting into the swing of what asset allocation is all about? For more great ideas on how to remain at the top of your investment game, I hope you’ll subscribe and follow me on LinkedIn, or meet me out on the course for continued conversations.