Key Takeaways
- Strategic asset allocation is an investing strategy that helps you determine what percentage of your assets should be in stocks, bonds, and cash.
- Once you have decided upon an allocation, you stick with that allocation for many years, assess it often, and rebalance it when necessary.
- Strategic asset allocation takes a more passive approach to investing, whereas tactical allocation involves more actively managing a portfolio.
- Many investors use a combination of strategic and tactical asset allocation.
What Is Strategic Asset Allocation?
Strategic asset allocation is an investing strategy. It aligns the makeup of your portfolio after your personal tolerance for risk. There are many models to meet your needs, whether they are more ambitious or more conservative. In practice, strategic asset allocation can help you figure out how much of your money should be invested in broad categories of investments, such as stocks or bonds, along with smaller sub-categories, such as U.S. small-cap and mid-cap stocks.
Once you have decided upon an allocation, you stick with that allocation for many years. If there is a main selling feature of strategic asset allocation it is to help you work steadily toward a financial goal over a long span of time and to avoid making emotional short-term decisions based on current market events.
Note
Investors use asset allocation as a way to diversify their portfolio.
This traditional approach is based onModern Portfolio Theory, which claims that markets are efficient and that they follow patterns that are more reliable than human investors. Rather than trying to "bet" on financial trends, it claims that you are better off taking advantage of the built-in efficiency of the market, which is best done through a fixed set of assets and a balanced portfolio.
How Strategic Asset Allocation Works
There are many models of asset allocation, and all are based on risk tolerance. If you're not sure what mix of investments to choose, and in what amount, there are many online tools to help. You can also talk to a financial professional for more detailed and custom advice. Whether you find a questionnaire or calculator online or visit an advisor, all are designed to measure your comfort level with risk, which can then be translated into a proper asset allocation.
For example, if you have a high tolerance for risk, and a long time to invest, an allocation recommendation might suggest that you have 70% stocks/20% bonds/10% cash. A more modest approach would suggest a breakdown of 60% stocks and 40% bonds. These are common models, and you might see them called a “70/20/10” portfolio or a “60/40” portfolio.
In general, the greater your tolerance for risk, the more aggressive you can be when you invest. This means putting more money into stock if your aim is to maximize long-term growth.
Maintaining Your Asset Allocation
Once you land on your asset allocation strategy, you have to maintain it. Don't just set it and forget it. You should check your portfolio on a regular basis to make sure it's still aligned. You may wish to rebalance it on a pre-set schedule (annually, for example) so that if any portion is off, you can restore the original allocation.
For instance, say you started with an asset allocation that targets 60% stock and 40% bonds, but 70% of your portfolio consists of stocks. Under a strategic asset allocation approach, even if stocks are performing well at present, you should sell the excess 10% in stocks in order tobring your stock allocation back down to the target of 60%. You should then reinvest the proceeds into bonds.
This is because the strategic asset allocation approach involves sticking with your original plan, rather than reacting to what is currently occurring in the markets, trusting that it will pay off in the long run.
Note
If you obtain information that warrants a change in the allocation itself, it's acceptable to change it and then stick to it. This would be something that alters your own comfort with taking more (or less) risk, not simply a shift in the way the assets perform, nor a shift in the market itself.
Strategic Asset Allocation vs. Tactical Asset Allocation
Strategic asset allocation takes a more passive approach to investing, whereas tactical asset allocation involves a more active approach. The best method for you depends on your investing style.
| Strategic Asset Allocation | Tactical Asset Allocation |
|---|---|
| Hands-off approach | Greater level of control |
| Buy and hold strategy | Involves trading often |
| Good for long-term time horizon | Good for short-term or medium-term time horizon |
| Works for newer investors | Demands more investing expertise |
| Better for emotional investors | Requires a degree of control over impulse trading |
When a Strategic Asset Allocation Works
A strategic asset allocation approach may be for you if the following apply:
- You prefer to be hands-off: With this approach, you purchase investments in a certain mix and only rebalance them (buy some and sell others) when the allocation diverges from that mix.
- You want to buy and hold: You'll purchase investments and keep them over the long term. This means you seldom have to move money around or incur the associated transaction fees.
- You have a long time horizon: The longer you have until you need the money in your portfolio, the more appealing this method will be, since there is still plenty of time for the market to bounce back from potential downturns.
- You have limited investing experience: This method requires research but it doesn't require deep insights into market trends. You may want to choose this approach if you don't have the experience needed to act on ongoing market events.
- You're an emotional investor: A strategic asset allocation forces you to adhere to your original asset allocation, no matter what the market brings. If you know yourself to be an impulse shopper or panic buyer (or seller), strategic asset allocation will help to ease reckless trades.
When A Tactical Asset Allocation Works
A tactical asset allocation approach may be for you if the following apply:
- You want greater control: If you don't necessarily trust in the market to steer your investments in the right direction, prefer to maintain control over your trades, and wish to reserve the right to make your own trading choices, this strategy may be a better option.
- You're willing to trade often: The opposite of a buy-and-hold strategy is a trading approach where you don't simply stick to your original investment choices over a period of years. Instead, you watch them on an ongoing basis and act on investment opportunities as they arise. This may result in moving around money more often, which can incur higher transaction fees.
- You have a short- to medium-term time horizon: A tactical approach may be more suited for money in a regular investment account that you're looking to grow in the short term rather than for a defined long-term goal.
- You have more expertise: If you have a lot of insight into the market and know how to prudently act on changes, this option may work for you. But there are no guarantees you will get better results than with a strategic asset allocation.
Note
Many financial managers use a combination of strategic and tactical asset allocation to increase both the stability and flexibility of their funds.
Do You Need Strategic Asset Allocation?
Your investing strategy will depend on a number of factors. These include:
- The timeline for your investing goals
- Your risk tolerance
- Your comfort with investment decisions
The strategic asset allocation is an ideal choice for the typical buy-and-hold investor who may not have extensive investing experience but wants a hands-off approach to saving for the long-term goal of retirement. Investors who prefer to actively manage their investments over a shorter period of time should consider a tactical asset allocation strategy.
You may have the same risk tolerance your whole life, meaning that your comfort with volatile markets in the present moment will stay the same as you age. Even so, as the time comes to withdraw funds from an investment account, you may want to reduce your exposure to risk because you have less time to recover investment losses during a downturn.
To explain, most investors shift to a more conservative investment allocation strategy as they near retirement, allocating more of their portfolio to bonds and less to volatile stocks.
If you are unsure whether a strategic asset allocation is right for you, consult with a financial adviser.
How to Get a Strategic Asset Allocation
Follow these steps to create a portfolio that suits your investor profile.
Determine Your Risk Tolerance
This is the amount of volatility you are willing to tolerate. If you can remain calm when the market is falling, you can be more aggressive by putting more money into stocks. If you tend to get jumpy during a downturn, you may want to invest more conservatively through more bonds or cash.
Consider Your Time Horizon
How long do you plan to hold on to your investments? If you don't think you'll need the money for a long time, you can afford to be more aggressive. In general, the longer your time horizon, the less upset you should be by the high volatility that comes with a more aggressive allocation.
Know Your Objectives
Is your goal to achieve capital growth, fixed income, or a mix of the two? Growth generally requires a more aggressive investment allocation, while income calls for a more conservative approach.
Determine Your Allocation
Asset classes include cash, bonds, or stocks. Look at the long-term expected returns and risk level of each asset class when deciding on the target percentage for each class. Stocks are the riskiest, bonds are less risky, and cash is the least risky. The higher the risk, the greater the potential for both growth and loss.
Break Down Each Asset Class
Stocks, for example, can be broken down into large-cap, small-cap, U.S., international, and emerging markets, to name a few sub-categories.
Develop a Plan
Assign a target percentage allocation for each underlying category. For example, decide to use 10% to U.S. small-cap stocks.
Purchase Funds
You can buy many individual funds to make up your planned allocation in sum. Or you can rely on a fund that does the work for you. For instance, you could buy a balanced mutual fund, which includes stocks and bonds in a single fund, usually at fixed percentages (for example, 60% stock/40% bonds). Many 401(k) plans also offer "model" portfolio allocations that do the work for you.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
Investor.gov. "Beginners’ Guide to Asset Allocation, Diversification, and Rebalancing." Accessed June 15, 2021.
4Thought Financial Group. "Rethinking Modern Portfolio Theory: Strategic vs. Tactical Asset Allocation." Accessed June 15, 2021.
