Asset allocation is based on the understanding that different types of assets do not move in concert, and some are more volatile than others. It is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance, and investment horizon. The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.

Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio. A diversified portfolio contains a mix of distinct asset types and investment vehicles in an attempt at limiting exposure to any single asset or risk. Since it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all of the sectors over time while reducing volatility at any given time. Basically, it involves spreading risk and reward across various classes of securities, sectors of the economy, and geographical regions.