A portfolio analysis adds up your investments in various categories to determine your asset allocation, a measure of the anticipated risks and returns of a portfolio.

The historical returns of stocks are higher but so are the risks. Bonds have less risk and less return. More importantly, there is a historical inverse correlation between stocks and bonds so that bond prices usually rise when stock prices fall and vice versa.

These historical trends were broken during the past year as almost all asset classes fell. Since March 2009, both bond and stock prices have risen dramatically. The recent crash and credit crisis has made people more cautious and we can expect that money will continue to flood into the perceived safety of bonds. How long can both stocks and bonds rise? When will the inverse relationship reassert itself? Which is the more powerful emotion? Will fear continue to drive money into bonds or will greed goad investors into the more risky stock market?

Asset allocation can dampen the emotional driving forces behind your investment decisions.

In an October 1999 WSJ article, Jonathan Clements examined the finer points of asset allocation with some investment professors. Most people calculate their asset mix by adding up the value of their stocks, bonds and cash. An old maxim is that the percentage of bonds and cash in your portfolio should approximate your age. The truest maxim may be “Go with your gut.” If you can’t sleep at night worrying about your investment portfolio, then it’s time to ease up on the risk in your investments.

So what about your house? House prices historically rise 3 – 4% per year, a return that approximates the return on a bond. When calculating your asset mix, should you include the equity of your house in with the total of your bond investments? A real estate professor that Clements interviewed maintains that a house is not a conservative investment. Historical data shows that, over a period of three years, housing prices have sometime fallen 40%. Remember, this article was written in 1999. How many people heeded that advice and treated the equity in their house as though it were more like an investment in a stock fund?

An investments professor interviewed by Clements “suggests treating your mortgage as a negative position in bonds”, subtracting the amount of the mortgage from the total bonds in your portfolio.

The point of analyzing a portfolio is to assess the risks that your investments are exposed to and that you personally are comfortable with. In this past year, too many older Americans found out that they were exposed to a lot more risk that they thought.