Portfolio optimization is the process of choosing the proportions of various assets to be held in a portfolio, in such a way as to make the portfolio better than any other according to some criterion. The criterion will combine, directly or indirectly, considerations of the expected value of the portfolio's rate of return as well as of the return's dispersion and possibly other measures of financial risk.

In finance, diversification is the process of allocating capital in a way that reduces the exposure to any one particular asset or risk. A common path towards diversification is to reduce risk or volatility by investing in a variety of assets. If asset prices do not change in perfect synchrony, a diversified portfolio will have less variance than the weighted average variance of its constituent assets, and often less volatility than the least volatile of its constituents.

The simplest example of diversification is provided by the proverb "Don't put all your eggs in one basket". Dropping the basket will break all the eggs. Placing each egg in a different basket is more diversified. There is more risk of losing one egg, but less risk of losing all of them.

Diversification is one of two general techniques for reducing investment risk. The other is hedging.

Asset allocation is the rigorous implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of each asset in an investment portfolio according to the investor's risk tolerance, goals and investment time frame.

Asset allocation relies on what investors call diversification, and what professionals call correlation. The idea is to structure a portfolio of dissimilar securities that tend to move in opposite directions so that when some are waning, others are waxing, thus reducing losses with the potential of achieving better risk-adjusted returns. However, more fundamental than diversification are risk measurements and return forecasts. Risk, return and correlation are the building blocks to achieve the optimal asset mix for the more than 50 asset allocation models we know of worldwide. The linchpin and most important factor in asset allocation modeling is the evaluation of risk.