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Saturday, July 20, 2024

What Is Strategic Asset Allocation? Definition + Allocation Strategies

Assess your risk tolerance 

Risk tolerance is how much risk you want to expose your capital to. An aggressive approach might not be for everyone, even if they have 20 years plus to ride out the markets. 

Its important that you are comfortable with your risk tolerance because there is always an opportunity for loss in investing. The higher the risk, the higher the chance of loss.

But there’s also a chance of higher earnings. The point is, you need to be comfortable with the potential of your risk class compared to the potential for total loss. 

Determine your goals 

What is the point of investing and how will strategic asset allocation play into those goals? If your goals are to spend as little time micro-managing your investments as possible, then strategic allocation is your best investment friend.

Add to that investment automation and you’ll have plenty of free time to do whatever you want instead of scouring newspapers, widgets, and indicators for hours a week trying to maximize your returns. 

Sure, there is a time to intervene but knowing when and how often is what will allow you to strike a good balance. 

  • You want to spend less time figuring out financial jargon 
  • You prefer investment automation 
  • Risk tolerance is worked into your allocations 
  • There’s a planned review every year to determine whether you’re still on the right course and whether your allocations are where they need to be 

Purchase funds in each asset class

This is a simple way to make sure you have a nice, diverse investment portfolio. And diversity matters. Remember when financial pundits were telling everyone that property was the safest portfolio and that the likelihood of a market crash was just, well silly? 

Turns out that did happen and well, we literally refer to it as the mortgage crash. Now, property is still worth looking at when considering your investment strategy because the market did quite a rebound. But here’s the thing.

Don’t tie all your money up in that one asset that seems to be going well at that point in time. Those who were able to wait it out managed to make their money back and then some. Those who retired at the time of the crash, not so much. 

Split your assets as much as possible to increase your chances of good returns and reduce your risk. Even when you’re investing in an asset, for instance, stocks, split those funds even more. Consider index funds that include a basket of funds so you’re as diverse as you can possibly get. 

Rebalance your portfolio every 12-18 months

In order to stay balanced, you’ll need to check out your portfolio and rearrange funds in order to stay in accordance with the allocation percentages you set as a goal.

Strategic asset allocation vs tactical asset allocation

Now, its worth mentioning that these asset allocation strategies don’t exist in isolation. Also, strategic asset allocation is just one method of dealing with your investments. There’s also no rule that says if you choose one method, you need to stick to it for the next thirty or forty years. 

Its not unusual for you to use several methods at times, even if you have a main method. For instance, you can opt for strategic allocation, and at times, employ tactical allocation. 

Tactical allocation simply means you’re in the thick of it all the time, making even the minutest decision regarding your investments. It’s the opposite of the hands-off strategic allocation model.

Fund managers often use a tactical approach to asset allocation and it works, because they know what they’re doing. The goal here is to maximize profits and when this is done, the portfolio is returned back to its original state. Its only supposed to be a temporary measure. 

There are other allocation methods too. 

  • Constant Weighting Asset Allocation: You allocate certain percentages to certain asset classes, for instance, 80% to stocks and 20% to bonds. When the markets shift and you’re suddenly 25% in bonds, you immediately adjust this. Some investors allow the balance to tilt by up to 5% before they adjust their investment split. 
  • Dynamic Asset Allocation: You’re in a constant game of buy and sell. When markets are weak, you sell and when they pick up, you buy. This method plays into the strengths of portfolio managers. 
  • Insured Asset Allocation: This method allows you to establish a base profit margin and should the investment dip below it, you start moving funds to secure investment assets that carry little to no risk. 
  • Integrated Asset Allocation: This method is entirely focused on risk and may include aspects of the other methods. Assets are chosen with the investors risk tolerance in mind and all decisions regarding investments are weighed up against risk, not possible future returns. 

To conclude 

Investing can be as easy or as hard as you want it to be but when your portfolio strategy is all about asset allocation, you’re one step closer to a healthy asset mix. 

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