Creating an investment portfolio that can help you maintain your quality of life during retirement requires an understanding and application of many subjects, including the foundations of portfolio optimization: the fundamental concepts of diversification and asset allocation.

Diversification is a valued investment strategy. There are two types of investment risks: unsystematic and systematic. Diversification can help you manage or control what is known as unsystematic investment risk. For example, a properly diversified portfolio should include investments in a variety of industries and asset classes such as small-company stocks, international government bonds, and fixed annuities. Studies show that generally unsystematic risk decreases as the number of stocks in a portfolio increases. The second type of investment risk is known as systematic risk. It results from factors such as national economies, inflation or interest rates. This type of risk cannot be reduced by diversification. While diversification does not assure a profit or protect against a loss, it may be managed through asset allocation.

Asset allocation is investing in assets with dissimilar performance. This is true because when investing in assets with similar behavior, whichever direction an investment takes, the others generally follow. With proper asset allocation, the upward movement of one asset may offset some part of the downward movement of another. Up until recently, the explicated asset allocation process required some detailed mathematical calculations. Fortunately, the advent of powerful computers and specialized software make asset allocation much more accessible to a broader public. Of course, past performance is no guarantee of future performance. Additionally, asset allocation does not assure a profit or protect against a loss.

The key to portfolio optimization. Portfolio optimization programs allow you to compare the "optimal" or "efficient" portfolios to a current portfolio. Numerous charts and graphs can illustrate historical ranges of returns, dollar growth and probabilities of the loss of purchasing power. Just remember that even the most sophisticated optimization program is only as good as its input. And all the optimization in the world cannot help an investor realize retirement plan investment goals if the program is not implemented. That is, when the "optimal" portfolio has been selected, the investor should choose specific investments that match the "optimal" portfolio's asset classes. The investor should also re-optimize the portfolio each year to ensure that allocations continue to match the plan.