You might have heard some recent rumblings about volatility in financial markets that have you rethinking your asset allocation strategy. It’s not a bad thing to take an active interest in your investment portfolio.
Whether planning for the far-off future or taking steps to safeguard your upcoming retirement, understanding the shape of your portfolio is an essential factor in wealth creation.
Tactical asset allocation and strategic asset allocation are two different approaches to shaping an investment portfolio. While the differences between the two can seem cut and dry, experienced financial advisors know the decision is more nuanced.
So, let’s unpack the similarities and differences between tactical and strategic asset allocation to help you build a solid foundation for the future.
Tactical and strategic asset allocation explained
Strategic and tactical asset allocation are two approaches to diversifying the assets in your portfolio – your shares, property and infrastructure, bonds and cash. The two approaches differ in their investment objectives, time scales, and risk strategies.
Strategic asset allocation
Strategic asset allocation is a buy-and-hold strategy. Investors and financial planners focus on reaching long-term financial goals by maintaining a relatively unchanged mix of asset classes (shares, property and infrastructure, bonds and cash) over several years.
The goal is to build a stable portfolio that aligns with your overall financial plan.
Tactical asset allocation
Tactical asset allocation is a short-term strategy that encourages investors to take advantage of market conditions by frequently adjusting their portfolios. Rather than being guided by an individual’s investment targets, tactical asset allocation reacts to the market.
It’s more active and more risky. Proponents might tell you that higher risk comes with higher profits if you know what you’re doing. However, research shows that tactical asset allocation has little to no impact on long-term returns.
Which begs the question: Why take the risk?
Key differences between strategic and tactical asset allocation
|Characteristic||Strategic asset allocation||Tactical asset allocation|
|Time horizon||5-10 years or more||3-6 months|
|Frequency of adjustments||Periodic (e.g. annually)||Frequent|
|Goal||Meet long-term financial goals||Generate higher returns in the short term|
Asset allocation approaches: Examples and outcomes
Strategic asset allocation
Strategic asset allocation aims to create a diversified portfolio that balances risk and return over a long-term investment horizon.
In most cases, strategic asset allocation is a more level-headed choice for building a retirement nest egg.
Strategic asset allocation is typically seen as investing in blue chip shares, property and infrastructure and bonds rather than start up companies, emerging industries or other speculative assets. The theory goes that this approach shields the individual from market volatility.
There are minimal adjustments to the asset mix, if any. Cooler heads prevail; strategic investors take the long view on stable and sustainable wealth creation.
Of course, asset classes have enormous diversity.
A good financial advisor in Perth can use this variation to fine-tune risk exposure based on the investor’s style and goals. While this might sound like we’re verging on tactical territory, the overall shape of the portfolio remains strategic, while actively investing (as opposed to set-and-forget passive investing) ensures you are always moving in the right direction.
Tactical asset allocation
Investors following a tactical approach might hold a higher proportion of shares that are tipped to grow quickly, with the remainder invested in stable assets as insurance against a bad bet.
Assets are bought and sold more frequently, often changing the portfolio’s overall profile to capitalise on market movements. For example, investors might sell shares to buy bonds if they believe they can make a quick gain.
The goal is to take advantage of market fluctuations by regularly reshaping the overall portfolio.
There is a popular theory that tactical asset allocation can help younger, more risk-tolerant people build wealth quickly.
But aside from some outliers scenarios, or incredible luck, there is no evidence to support a tactical approach over a longer investment horizon, say five years or more.
Which asset allocation strategy is better?
Financial planning is never black and white. As we mentioned earlier, there is no “best” asset allocation approach that applies to every investor.
However, there is a “best” asset allocation approach for you. The right financial planning approach is the one that makes you comfortable and achieves your goals.
This guide to strategic asset allocation vs tactical asset allocation is designed to help you have an informed conversation with your financial advisor in Perth and give you the tools to manage your financial future.
It doesn’t, for example, account for the question of investing for yield vs capital growth, which we tackled in a previous article.
Our philosophy as strategic financial planners
We would like to believe that any respectable financial advisor in Perth will steer clear of recommending one textbook investment approach.
Every client has unique goals, characteristics and preferences. For this reason, we always advocate a personalised investment strategy that takes into account a long list of factors, including but certainly not limited to:
- Short and long-term investment goals
- Financial position
- Risk tolerance
- Knowledge and confidence
How does this wash out in asset allocation? Weighing up everything we’ve discussed, the resulting asset mix can be boiled down to three key concepts.
Wealth is built on a stable foundation
Strategic asset allocation aims to provide steady long-term returns. Every drop helps fill the bucket over five, 10, 20 or even 50 years.
Market volatility can cause turbulence for even the most conservative and experienced investors. The advantage of holding strategic assets is that these disturbances are only ripples on the surface, not holes in the bucket.
A little risk can be healthy
Market conditions change quickly. Tactical asset allocation seeks to exploit that volatility. However, the same unpredictability can tank the value of assets before an investor has time to recover them.
This is why we tend to recommend investment portfolios take on a strategic asset ‘shape’, with flexibility to allocate some capital to higher-risk investments if this strategy suits the client’s goals. Over time, that risky segment will likely shrink to stabilise the portfolio. But if you are still decades away from retirement, we are happy to have a conversation about risk and reward.
Don’t lose sight of your goals
When the share market is strong, it’s tempting to think the good times will last forever. The same goes for real estate, bonds or cash holdings.
However, allocating assets based on external signals removes your goals from the equation.
Wealth creation is highly individualised. While there are guidelines that can help you get informed about your portfolio, there are no hard and fast rules that say asset allocation depends on age or any other factor.
There are also no shortcuts.
The best financial advisors in Perth aim for security and confidence, not flashy investment strategies that expose your nest egg to risk.
Get personalised advice from Perth’s best strategic financial planners
The bottom line is that financial planning is personal. No two scenarios or investment objectives are the same.
As experienced financial planners, we help hardworking Australians develop strategies to achieve their financial goals, providing objective advice and long-term support.