Asset Allocation is striking a mix or balance between growth (equity) and income (bond) investments within a portfolio. The common thought is that Asset Classes that are different from each other perform differently to each other. There are some basic steps with setting up an Asset Allocation Portfolio:
- Determine Risk Tolerance, the Time Horizon for this investment and the Goals of the investor.
- Choose the Asset Classes.
- Choose the percentages of the Asset Classes.
- Select an appropriate range of the percentage within each Asset Class.
In this article, I will discuss two types of Asset Allocation models: Strategic Asset Allocation and Tactical Asset Allocation.
Strategic Asset Allocation
This approach, Strategic Asset Allocation, is a more familiar approach along the lines of “Buy and Hold”. Using Strategic Asset Allocation the investor first will determine their risk tolerance, time frame and objectives or goals for that investor. Once that is documented and understood an allocation portfolio is built around a certain percentages of Bonds, Stocks and Cash. This mix should, in theory, generate the necessary returns to match the tolerance, time frame and goals of the investor.
Related article: How to mix your investments?
Once the investor has determined the percentages within the portfolio that portfolio will be re balanced on a particular date. An example would be that the investor has 60 percent equity and 40 percent bonds. 12 months later the portfolio is now 65% equity and 35% bonds, the investor will move 5% profit from equity and place it in the income or bond portion of the portfolio, starting year two at the agreed upon 60/40 equity/bond mix. This strategy promotes buy and hold and sell high buy low philosophies. Another strategy is called Tactical Asset Allocation which allows more flexibility.
Related article: Proper Diversification using correlation charts
Tactical Asset Allocation
Tactical Asset Allocation is similar to Strategic Asset Allocation in that they both promote a long term view of staying invested in the portfolio percentages. Where Tactical Asset Allocation is different from SAA is that Tactical allows from some movement or range within each asset class. For example, a 60/40 equity/bond SAA would look more like 50-60 % equity and 40-50% bonds in a TAA. With Tactical Asset Allocation the investor has some wiggle room if they feel that perhaps equities are on the rise they can hold more equities and reduce their fixed income mix or if the investor feels equities have peaked and are on the way down they can increase their fixed income or bond holdings.
Related article: Model Investment Portfolios
Where Strategic Asset Allocation is a buy and hold strategy Tactical Asset Allocation mirrors more of a market timing strategy. As I mentioned previously Tactical Asset Allocation gives the investor some flexibility in their holdings that Strategic does not but Tactical Asset Allocation also requires a bit more knowledge and expertise by the investor. They will have to pay more attention to their portfolio with a Tactical strategy.
No matter what strategy you choose, Tactical or Strategic, there are no guarantees that one Asset Allocation strategy will outperform the other. One thing that is true is that as an investor, if you keep a long term view and review your portfolio regularly you will be successful.
Related article: How to review your investment portfolio?
Do you believe asset allocation is important? If so, what model do you subscribe to?