Series 66

Portfolio Management Strategies, Styles and Techniques - Asset Allocation and Strategic vs. Tactical Asset Allocation

In simple terms, asset allocation refers to the balance between growth-oriented and income-oriented investments in a portfolio. This allows the investor to take advantage of the risk/reward tradeoff and benefit from both growth and income. Here are the basic steps to asset allocation:

  1. Choosing which asset classes to include (stocks, bonds, money market, real estate, precious metals, etc.)
  2. Selecting the ideal percentage (the target) to allocate to each asset class
  3. Identifying an acceptable range within that target
  4. Diversifying within each asset class

Minimizing risk while maximizing return is any investor's prime goal, and the right mix of securities is key. See the article Achieving Optimal Asset Allocation for more on optimizing your asset allocation strategy.

Of course, the appropriate mix for a particular client depends upon many of the factors discussed in the Analyzing Your Client's Profile section, including risk tolerance, time horizon and financial goals. For example, an IA with a client who owns commercial real estate properties or a number of rental homes would probably not recommend REITs or other real estate securities in the portfolio. Asset allocation is explained in detail later in this section.

Risk Tolerance
The client's risk tolerance is the single most important factor in choosing an asset allocation. Most IAs will create a risk tolerance questionnaire (or use one provided with their financial planning software) to make sure they have an accurate measure of risk. At times, there may be a distinct difference between the risk tolerance of a client and his/her spouse, so care must be taken to get agreement on how to proceed. In addition, risk tolerance may change over time, so it is important to revisit the topic periodically.

Time Horizon
Clearly, the time horizon for each of the client's goals will affect the asset allocation mix. Take the example of a client with a very aggressive risk tolerance. The recommended allocation to stocks will be much higher for the client's retirement portfolio than for the money being set aside for the college fund of the client's 13-year-old child.

Strategic vs. Tactical Asset Allocation

  • 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 IA 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.


Learn more about tactical and strategic asset allocation, as well as insured, dynamic, integrated and constant-weighted asset allocation strategies within the article: Asset Allocation Strategies.




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