Q We have inherited some vacant land here in Minnesota and know we should consider it within our asset allocation calculations but wonder exactly how.

We are in our mid-50s and, excluding this land, have about 46 percent of our portfolio in stocks (spread among large, small and international index funds) and 54 percent in bonds and cash, so somewhat conservative. When you include this land, we have 37 percent in stocks, 41 percent in cash and bonds and 22 percent in this real estate. The real estate percentage feels too high for me and too low for my husband. We don't intend to build a home on this land. We plan to sell it probably when we retire, or sooner if prices rebound.

ELAINE

A It's an intriguing question. Let me briefly define asset allocation and say why it matters. The fundamental notion informing modern finance is the proposition that returns are only earned as compensation for taking on risk. For instance, stocks are riskier than bonds since equities represent the uncertain rewards for entrepreneurship, while bonds are long-term contracts that spell out when borrowers must make principal and interest payments. Despite the hours people spend agonizing over mutual funds and worrying over the market's every twist, asset allocation is the main determinant of your portfolio's performance. Asset allocation is a fancy way of saying how you divide your money among the investment options available to you.

So, the essence of asset allocation is the inevitable trade-off between risk and return. The more risk you are willing to take, the greater your chance for higher returns -- or losses. And vice versa. The main assets are stocks (both domestic and international), bonds (foreign and domestic), cash and real estate, although that list was expanded over the past decade or so to include commodities. One of the fundamentals of asset allocation is diversification. The trick is to mix and match the major asset groups to create a well-diversified portfolio so that when some assets zig, others zag.

Since it's an investment property, I would include it in your asset allocation. Land offers several potential benefits. Among them, it's a hedge against inflation and it acts differently than fixed-income securities. The drawbacks include it's relatively illiquid (not easy to sell quickly) and the risk is concentrated in one region.

Now, I can't really say whether you have too much, too little, or just the right amount in real estate. That would take a lot more information and discussion to figure out. However, my initial reaction is that it's a very large percentage of a portfolio to be exposed to just one alternative investment. I like the rule-of-thumb that suggests any one investment bet shouldn't exceed 7 to 10 percent of a portfolio. That way, if the investment goes sour your standard of living doesn't take much of a hit, but if it pays off you still pocket a meaningful gain.

To delve further into the topic I'd pick up a copy of David Darst's "The Little Book That Saves Your Assets: What the Rich Do to Stay Wealthy in Up and Down Markets."

Chris Farrell is economics editor for American Public Media's "Marketplace Money." Send questions to cfarrell@mpr.org.