The four-step asset allocation method widely used today was born out of the investing concepts of David Swenson, the former investment officer of the Yale Endowment Fund. The steps are as follows:

First, determine your investment objectives and risk tolerance.

Second, choose different types of assets to invest in.

Third, decide asset composition in your portfolio.

Finally, regularly review and rebalance your portfolio.

Determine your investment objectives and risk tolerance.

If you are a conservative investor, you could feel uneasy after investing in high-volatility, high-risk assets. But if you pursue an aggressive investment strategy, you may not put most of your money in low-yielding assets.

Therefore, before making an investment, you must know your investment objectives and risk tolerance. Typically, you take a test or questionnaire to validate your risk tolerance before opening an account with a broker. However, people with the same risk tolerance can end up having different investment portfolios because they also take into account their investment objectives.

You may favor industry-themed funds if you believe in the future of an industry and want your investments to share that growth;

You might opt for steady and well-balanced investments if you want to lower investment risks and save for childcare;

If your investment goal is to save up for retirement and manage your finances, financial products with low-to medium-risk, like money market funds or bond funds, might be better options for you.

Choose different types of assets to invest in.

Is it still considered asset allocation if you only buy Apple and Microsoft stocks?

Considering they are both big tech companies, these two investments are highly correlated and the investment risks of such a portfolio are not well spread.

Asset allocation generally refers to investing in different asset classes with low correlation rather than buying two equities of the same type with high correlation.

Generally, the higher an asset's income-generating potential, the more risky and volatile it is. The four common types of assets are listed as follows:

Equity assets, including stocks and their derivatives like options or futures, usually have high income-generating potential but high volatility, too.

Fixed income mainly refers to bonds, which can be further divided into treasury bonds, investment-grade bonds, and high-yield bonds. Their income potential and volatility are generally lower than stocks and higher than cash.

Cash, including bank deposits, monetary funds, and other cash equivalents, are generally known as the safest assets, but it's difficult for them to outperform inflation.

Alternative assets are starkly different from the first three traditional investment categories. Commodities, real estate, hedge funds, and artwork are among the most common ones. They are generally considered an aggressive part of a portfolio. It's better for investors to have the relevant professional knowledge before considering trading such assets.

It can be simple for individual investors to trade stocks, but not for some bonds and alternative assets. Funds that hold such assets, such as bond funds, REITs, or commodity funds, maybe a good choice for certain investors. There are a wide variety of funds that require a low initial investment to choose from.

Decide asset composition in your portfolio.

If you decide to have a diversified portfolio, which asset should you prioritize, stocks, currencies, commodities, industry-themed funds, bond funds, or currency funds?

Apart from considering your risk tolerance, you may also take into account other investment strategies, including a balanced portfolio, life-cycle strategy, Merrill Lynch clock, and tactical and strategic asset allocations.

Regularly review and rebalance your portfolio.

Regular review is also necessary for asset allocation. Over time, the weighting of each asset class in your portfolio is subject to change due to its market value shift, skewing your portfolio’s risk level.

Rebalancing is the process of restoring the predetermined ratios so that your portfolio as a whole aligns with your investing goals and risk tolerance.

For instance, if a growth fund has far better-than-expected return this year, you might consider rebalancing your portfolio by transferring some capital invested in this fund to a value fund.

In addition, your investing experience and living conditions may lead to changes in your preference. You may consider adjusting your asset mix after reviewing your portfolio.

Last, pay attention that asset allocation and diversification do not ensure a profit or guarantee against a loss. Rebalancing may also cause a potentially heavier tax burden.