Portfolio diversification is the best way to maximize your profits, while minimizing your risk.  However, with so many options to choose from, it can be difficult to find your optimal level of asset allocation.  Based upon your risk tolerance and investing needs, there are several strategies for you to identify and maintain the ideal mix.
Asset allocation occurs when you divide your investments between different assets.  For instance, you could choose to invest in both stocks and bonds.  Because of the reduction of risk, asset allocation is one of the most effective ways to diversify your portfolio.

Classes of assets

In order to choose the optimal levels, it is important that you understand the fundamentals of each asset class.  
Large cap stocks are issued by companies with market cap of more than $10 billion, and thus, they generally are the most stable stocks.  Mid cap stocks are issued by companies with a market cap of $2-$10 billion.  Small cap stocks are issued by companies with a market cap of under $2 billion, and these tend to have the most risk.  

International securities are listed on the foreign exchange, and these allow you to diversify outside of the country, but do pose a certain level of risk.  For example, emerging markets are stocks from markets of developing countries, offering higher returns at higher risks.  However, you can invest in stocks of companies in mature, stable countries and expect to achieve the same risk-to-reward ratio as the United States. 

Fixed income securities include government and corporate bonds, and pay a set amount of interest, along with a return of the principal.  Money market securities are comprised mostly of treasury bills, and they are debt securities that mature in under a year.  Real estate investment trusts have an underlying asset of a shared pool of properties, instead of ownership in a company.

Making asset allocation work for you

The goal of asset allocation is to achieve the most profit for your risk level.  This means that you must have a good understanding of the risk-return characteristics of different investments.  In general, the higher your potential returns, the higher the risk exposure.  Usually, only investors that can afford to sit on their investments for long periods of time, or those with large amounts of capital, can take the danger of the riskier investments.
Because you can make big profits if you take big risks, diversification is important.  If you balance higher risk investments with lower ones, you will provide some insulation against market fluctuation and protect more of your capital.

How to achieve the right portfolio balance

To decide on your individual portfolio, there are several things to keep in mind.  You need to understand your risk tolerance, the amount of time that you are working with, what your goals are, and how much of an initial investment you can make.

You will find that many investment companies will create sample portfolios, ranging from conservative to aggressive, to provide clients with an idea of how asset allocation works.  Conservative portfolios are made up mostly of lower risk securities, while aggressive ones will have higher risk options.

Even if you prefer a conservative lean to your portfolio, a small exposure to the stock market can help you to beat inflation.  A moderately conservative portfolio allows you to take a little more risk, while still conserving capital.  You may utilize securities that pay high dividends at this level. 

On the other hand, a moderately aggressive model portfolio is balanced equally with fixed income securities and equities.  It is best to have a longer time frame for this style.  Aggressive portfolios are for those who are looking for long-term growth, and thus, they are willing to accept the fluctuations in the short term.  Different investors will also have different needs, such as how much liquidity they need.

Once you identified your risk level and strategy, you will still need to review your portfolio from time to time.  You may decide to raise or lower your risk depending on changes in circumstance, or you may need to re-evaluate different investments that are not performing up to your expectations.