Advanced Diploma of Financial Planning (ADFP) Practice Test

What is the primary purpose of asset allocation for investors?

1. To determine which investments will yield the highest returns

2. To guide how much of the portfolio should be invested in each asset class

3. To speculate on market movements

4. To ensure all assets are invested in stocks

The correct answer is: To guide how much of the portfolio should be invested in each asset class

The primary purpose of asset allocation for investors is to guide how much of the portfolio should be invested in each asset class. This approach is fundamental to creating a diversified investment strategy, which balances risk and return based on an investor's objectives, risk tolerance, and investment horizon. By properly allocating assets among different classes, such as stocks, bonds, and cash equivalents, investors can manage potential risks more effectively while aiming for optimal returns. Effective asset allocation can also help investors withstand market volatility by spreading their investments across various asset types that often behave differently under varying economic conditions. This careful distribution minimizes the impact of poor performance in any single asset class, thereby enhancing the overall stability of the investment portfolio. The other options focus on aspects that are not aligned with the overarching goal of asset allocation. While determining high returns is important, it is not the primary purpose of asset allocation itself; rather, it is a byproduct of strategic distribution across asset classes. Speculating on market movements and ensuring all assets are invested in stocks disregards the risk management benefits of diversification inherent in proper asset allocation.