Asset Allocation is the process of determining optimal allocations for the broad categories of assets (such as Stocks, Bonds, Cash, Real Estate, …) that suit your investment time horizon and risk tolerance.
While this process can be performed on any portfolio with two or more assets, it is most commonly applied to asset classes. This allocation is probably the most important decision and may account for more than 80 % of the return of the portfolio.
Each asset class will generally have different levels of return and risk. They also behave differently. At the time one asset is increasing in value, another may be decreasing or not increasing as much and vice versa. The measure used for this phenomenon is called the correlation coefficient.