Asset allocation is an integral part of making sure that your portfolio is properly balanced. It’s one of the most crucial factors in determining your overall returns.
Finding the right mix of stocks, bonds, cash, and other assets is a lengthy and critical process. It’s also very dynamic. And because of that, the asset mix should reflect your goals all the time.
Strategic Asset Allocation
This type of asset allocation follows a base mix of assets in the portfolio. It follows a proportional combination of assets depending on the expected rates of return for each asset class.
In this asset allocation type, you need to take into consideration your risk tolerance and investment timeframe. At the same time, you can set your goals and rebalance your portfolio according to it from time to time.
Strategic asset allocation is also very similar to buy-and-hold strategy. At the same time, it heavily supports diversification to minimize risks and improve returns.
The first asset allocation type means a buy-and-hold strategy even if the shift in values of the assets causes the portfolio to drift away from the original mix.
If you want to avoid this, you can use constant-weighting allocation. Using this approach, you will be continually rebalancing your portfolio.
As such, if one asset declines in value, you would purchase more of the asset. If the asset value jumps, you would sell it (and lock in profits in the process).
There is really to specific rule as to when you should rebalance your portfolio to its original mix. However, the most commonly followed rule of thumb is that you should rebalance your portfolio once a given asset class moves more than 5% from its original value.
Tactical Asset Allocation
Strategic asset allocation may be too rigid because it’s supposed to be used for the long-term. As a result, it may be necessary to occasionally engage in short-term, tactical deviations from the mix.
This way, you will be able to capitalize on the unusual investment opportunities. With this approach, you get the flexibility of adding market timing to the portfolio.
You will be able to participate in economic conditions that can be more favorable for one asset class than for others.
As such, tactical asset allocation may be a moderately active strategy because the overall strategic asset mix is put back to its original composition when you’ve already achieved the short-term profits you want.
Insured Asset Allocation
Using this asset allocation strategy, you have this base portfolio value. The portfolio shouldn’t drop below this base value.
The portfolio should consistently achieve a return that’s above its base, so you exercise active management.
And active management means you rely on analytical research, judgment, forecast, and experience to decide which are the most ideal securities you can buy, hold, and sell. Your overall goal is to increase the portfolio value as much as possible.
If the portfolio value drops below the base value, you then invest in risk-free assets like T-bills to make the base value fixed.