• Strategic asset allocation calls for setting target allocations and then periodically rebalancing the portfolio back to those targets as investment returns skew the original asset allocation percentages. The concept is akin to a "buy and hold" strategy, rather than an active trading approach. Of course, the strategic asset allocation targets may change over time as the client's goals and needs change and as the time horizon for major events such as retirement and college funding grow shorter.
     
  • Tactical asset allocation allows for a range of percentages in each asset class (such as Stocks = 40-50%). These are minimum and maximum acceptable percentages that permit the IA to take advantage of market conditions within these parameters. Thus, a minor form of market timing is possible, since the investor can move to the higher end of the range when stocks are expected to do better and to the lower end when the economic outlook is bleak.
Look Out!
On the test, strategic asset allocation may be linked with a "passive" investment style (see the Portfolio Styles section below), while tactical asset allocation is linked with an active" investment style.

Diversification
Once the target asset allocation percentages have been defined, the next step is to diversify. For example, within the bond or fixed-income class, investment options include corporate bonds, government bonds, municipal bonds, and so on. Further choices within the corporate bond category alone include short-term vs. long-term, investment-grade vs. high-yield (or junk) bonds, convertible, etc.

The range of options for stocks or stock funds is even wider. The information below refers to both individual stocks and mutual funds:

  • Market capitalization - market cap simply refers to the value of all of a company's outstanding common shares times the current market price. Stocks are classified based on size as follows:
    • Large-cap stocks $5 billion or more
    • Mid-cap stocks $1 billion - $5 billion
    • Small-cap stocks less than $1 billion
    • Micro-cap stocks less than $50 million
Diversifying across stocks with different market capitalizations is recommended. Typically, a larger allocation is made to large-cap stocks and smaller percentages to small-cap or mid-cap stocks.
  • Growth vs. value - stocks also differ by style. Typically, stocks (and mutual funds) are categorized as either growth or value oriented. Both styles have advocates who believe one is likely to outperform the other for different reasons.
    • Growth stocks are those whose earnings have been higher than average in the past and are expected to continue at a higher than average rate in the future. They typically pay low or no dividends and often trade at high P/E ratios. They tend to do well when the overall market is rising.
       
    • Value stocks generally have a strong balance sheet and higher dividends and are undervalued in the market given their earnings and asset values. Value stocks tend to outperform growth stocks during a falling market.

As in other contexts, diversification helps to reduce risk in a portfolio. Since different types of stocks have different characteristics, their rates of return will differ throughout the economic cycle. For example, if a portfolio is composed of 50% stocks, and a large-cap stock fund is the only investment, it may perform better during a downturn in the market than a small-cap fund, but the small-cap may outperform the large-cap during a market rally.

Portfolio Styles - Active vs. Passive

Related Articles
  1. Investing

    What Is Tactical Asset Allocation?

    Here's how tactical asset allocation, an extension of strategic asset allocation, works.
  2. Financial Advisor

    Asset Allocation vs. Security Selection: The Main Differences

    Both are important to a long-term investment strategy, but asset allocation and security selection have different missions.
  3. Financial Advisor

    An Introduction to Asset Allocation

    A portfolio is only as strong as its asset allocation. To create the right one, investors need to determine their risk tolerance, time horizon and goals.
  4. Investing

    Strategic Asset Allocation to Rebalance Portfolios

    This involves setting allocations for various asset classes, then yearly rebalancing the portfolio when it deviates from the initial settings.
  5. Investing

    What Is Strategic Asset Allocation?

    A strategic asset allocation takes a long-term approach to help an investor achieve their financial goals. Here's how it works.
  6. Managing Wealth

    6 Asset Allocation Strategies That Work

    Your portfolio's asset mix is a key factor in whether it's profitable. Find out how to get this delicate balance right.
  7. Managing Wealth

    Choose Your Own Asset Allocation Adventure

    There are many strategies to help balance your portfolio. Here are a few to get you started.
  8. Investing

    Why Asset Allocation Matters in Your Portfolio

    Asset allocation accounts for more than 90% of the investment process.
  9. Managing Wealth

    Achieving Optimal Asset Allocation

    Minimizing risk while maximizing return with the right mix of securities is the key to achieving your optimal asset allocation.
Frequently Asked Questions
  1. I'm about to retire. If I pay off my mortgage with after-tax money I have saved, I can save 6.5%. Should I do this?

    Only you and your financial advisor, family, accountant, etc. can answer the "should I?" question because there are many ...
  2. My wife and I both converted our Traditional IRAs to Roth IRAs over a decade ago and have invested the maximum allowed each year since. We're buying our first home soon. Do we both qualify for one-time, tax-free, $10,000 distributions?

    You and your spouse each qualify for a penalty-free distribution of up to $10,000 for the purchase, acquisition or construction ...
  3. Is a Thrift Savings Plan (TSP) a qualified retirement plan?

    Take advantage of the government's retirement plan for employees with the Thrift Savings Plan. As with a 401(k), contributions ...
  4. Who manages the assets in a Roth 401(k) account?

    Learn how to personally manage the assets in your Roth 401(k) plan and determine the best options available to help meet ...
Trading Center