Loading the player...

What is a 'Strategic Asset Allocation'

A portfolio strategy that involves setting target allocations for various asset classes, and periodically rebalancing the portfolio back to the original allocations when they deviate significantly from the initial settings due to differing returns from various assets. In strategic asset allocation, the target allocations depend on a number of factors – such as the investor’s risk tolerance, time horizon and investment objectives – and may change over time as these parameters change. Strategic asset allocation is compatible with a “buy and hold” strategy, as opposed to tactical asset allocation which is more suited to an active trading approach. Strategic and tactical asset allocation are based on modern portfolio theory, which emphasizes diversification in order to reduce risk and improve portfolio returns.

BREAKING DOWN 'Strategic Asset Allocation'

For example, 60-year old Mrs. Smith, who has a conservative approach to investing and is five years away from retirement, may have a strategic asset allocation of 40% equities / 40% fixed income / 20% cash. Assume Mrs. Smith has a $500,000 portfolio, and rebalances her portfolio annually. The dollar amounts allocated to the various asset classes at the time of setting the target allocations would therefore be – Equities $200,000, Fixed Income $200,000 and Cash $100,000.

After a year’s time, suppose the equity component of the portfolio has generated total returns of 10%, while fixed income has returned 5% and cash 2%. The portfolio composition now is – Equities $220,000, Fixed Income $210,000 and Cash $102,000.

The portfolio value is now $532,000, which means the overall return on the portfolio over the past year was 6.4%. The portfolio composition now is – Equities 41.3%, Fixed Income 39.5% and Cash 19.2%.

Based on the original allocation, the portfolio value of $532,000 should be allocated as follows –

Equities $212,800, Bonds $212,800 and Cash $106,400. The table below shows the adjustments that have to be made to each asset class to get back to the original or target allocation.

Thus, $7,200 from the equity component has to be sold in order to bring the equity allocation back to 40%, with the proceeds used to buy $2,800 of bonds and the balance $4,400 allocated to cash.

Note that while changes to target allocations can be carried out at any time, they are done relatively infrequently. In this case, Mrs. Smith may change her allocation in five years – when she is on the verge of retirement – to 20% equities, 60% fixed income and 20% cash, so as to reduce portfolio risk. Depending on the portfolio value at that time, this would necessitate significant changes in the composition of the portfolio to achieve the new target allocations.

RELATED TERMS
  1. Tactical Asset Allocation - TAA

    An active management portfolio strategy that rebalances the percentage ...
  2. Dynamic Asset Allocation

    A portfolio management strategy that involves rebalancing a portfolio ...
  3. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
  4. Portfolio Management

    Portfolio Management is the art and science of making decisions ...
  5. Aggressive Investment Strategy

    A portfolio management strategy that attempts to maximize returns ...
  6. Risk Parity

    A portfolio allocation strategy based on targeting risk levels ...
Related Articles
  1. 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.
  2. Investing

    Balanced Investing: Strategic Asset Allocation

    It involves setting allocations for various asset classes, then periodically rebalancing the portfolio when it deviates from the initial settings.
  3. 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.
  4. 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.
  5. 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.
  6. Investing

    6 Asset Allocation Strategies That Work

    An asset mix should reflect an investor’s current goals. Here are a few strategies for establishing the right allocation.
  7. Financial Advisor

    Which Asset Allocation is Best for Clients?

    Modern Portfolio Theory is showing its age. So which asset allocation model is best?
  8. Financial Advisor

    The 401(k) Emergency Boomers Need to Address Now

    The asset allocations of Baby Boomers’ 401(k)s are dangerously out of balance. Here's how to remedy that.
  9. Investing

    Asset Allocation Models: Comparing 3 Traditional Strategies

    Learn about the three most common asset allocation models: conservative, moderate and aggressive.
  10. Investing

    How to Create a Risk Parity Portfolio

    Learn about how risk parity uses leverage to create equal exposure to risk among different asset classes in portfolio construction.
RELATED FAQS
  1. How can I use asset allocation to properly diversify my portfolio?

    Understand how asset allocation works, and learn how you can use asset allocation to diversify your investment portfolio ... Read Answer >>
  2. What asset allocation should I use for my retirement portfolio?

    Learn the basics of planning an asset allocation strategy for retirement using risk constraints and return objectives to ... Read Answer >>
Hot Definitions
  1. Cover Letter

    A written document submitted with a job application explaining the applicant's credentials and interest in the open position. ...
  2. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  3. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  4. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  5. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  6. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
Trading Center