Asset Allocation and the Efficient Frontier
Asset allocation is a technique that determines the mix of asset classes (small stocks, big stocks, emerging markets, government bonds, corporate bonds, etc) that provides the highest probability of achieving a given return rate. For example, if you need a return of 12.2%, asset allocation might result in a mix of 40% large stocks, 40% government bonds, and 20% emerging markets. You should achieve the maximum rate of return for the least amount of risk at a given level of risk.
Asset allocation is different from security selection, which is the process of selecting the securities you will actually invest in for each asset class. For instance, choosing to put 40% of your portfolio in long-term growth stocks is an asset allocation decision; choosing to buy 100 shares of ATT stock is a security selection decision.