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Key Takeaways

• An asset allocation fund diversifies investments across asset classes, like stocks and bonds, optimizing for risk tolerance and market conditions.
• These funds aim to create an optimal portfolio based on modern portfolio theory, which emphasizes diversification for optimal returns.
• Asset allocation funds include balanced funds and target-date funds, offering varied mixes of asset classes for different risk tolerances.
• Investors can access these funds through mutual funds or ETFs, providing convenient diversification options.

What Is an Asset Allocation Fund?

An asset allocation fund is a type of mutual fund or ETF that invests in a mix of asset classes, such as stocks, bonds, and cash equivalents, to achieve diversification. These funds are designed to balance risk and return by adjusting their asset mix to match the investor's risk tolerance. Whether you’re looking for aggressive growth or conservative income, asset allocation funds offer various strategies tailored to your financial goals.

We'll explain how asset allocation funds work, the types available, and top examples to help you decide which option best fits your investment plan.

How Asset Allocation Funds Work

Asset allocation funds were developed from modern portfolio theory. Modern portfolio theory shows that investors can achieve optimal returns by investing in a diversified portfolio of investments included in an efficient frontier.

The standard applications of modern portfolio theory investing include an efficient frontier of stocks, bonds, and cash equivalents. Furthermore, modern portfolio theory outlines how a portfolio can vary its asset mix to tailor to the risk tolerance of the investor.

Types of Asset Allocation Funds

Asset allocation funds provide a simplified application of modern portfolio theory with varying allocations and combinations of assets for investors.

One of the most common types of asset allocation funds is a balanced fund. A balanced fund implies a balanced allocation of equities and fixed income, such as 60% stocks and 40% bonds. Investors will find numerous funds deploying the 60/40 mix as it has become a popular standardized strategy for investors seeking broad market diversification.

Asset allocation funds also offer varying levels of diversification based on risk tolerance. Investors seeking additional investing categories beyond just 60/40 will find many options, including conservative allocation funds, moderate allocation funds, and aggressive alloca­tion funds.

Life-cycle or target-date funds, usually used in retirement planning, are also considered a type of asset allocation fund. These funds are managed with a targeted mix of asset classes that start out with a higher risk-return position and gradually become less risky as the fund nears its targeted utilization date.

After determining a targeted asset allocation, funds can manage their investment selection in a number of ways. Some funds may choose to invest in a variety of exchange traded funds (ETFs) to represent different market exposures. Other funds may take a more active approach by using fundamental analysis to select top-performing securities in each asset class.

Overall, most funds will actively monitor and allocate or rebalance securities in response to evolving market conditions and economic environments.

Top Examples of Asset Allocation Funds

Below are examples of some of the investment industry’s top asset allocation funds.

The iShares Core Aggressive Allocation ETF (AOA): The iShares Core Aggressive Allocation ETF is a tracker fund that seeks to replicate the performance of the S&P Target Risk Aggressive Index. The fund invests in targeted ETFs that seek to replicate the Index. The Index is heavily weighted towards equities, targeting investors with a high risk tolerance.

The iShares Core Conservative Allocation ETF (AOK): The iShares Core Conservative Allocation ETF is a tracker fund that seeks to replicate the performance of the S&P Target Risk Conservative Index. The fund invests in ETFs that seek to replicate the Index. The Index is heavily weighted toward fixed income, targeting investors with a more conservative risk tolerance.

The Vanguard Balanced Index (VBIAX): Investors seeking asset allocation funds will find a number of options with Vanguard. The firm’s Vanguard Balanced Index fund invests approximately 60% in stocks and 40% in bonds. Its holdings seek to track two indexes, the CRSP US Total Market Index and the Bloomberg U.S. Aggregate Float Adjusted Bond Index.

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