Asset allocation means striking the right balance between stocks and bonds for your risk-and-return expectations.
"You have different pieces of the pie, and all those pieces react differently to different occurrences in the market," said certified public accountant Sheryl Rowling, principal of Rowling & Associates. "Some pieces go up while other pieces go down, so you will still get the average return of market, but you won't have the extreme ups and downs."
Even within the same asset class, there are ways to diversify, since it's hard to know where returns will come from. In stocks, that means owning some small, mid- and large caps, international and perhaps real estate holdings. In bonds, you'll want a combination of government, corporate and high-yield issues.