Tactical asset allocation is a well-recognized investment style. TAA has three actively adjusted and balanced fundamental asset classes: cash, bonds, and stocks. People utilize tactical asset allocation to improve their portfolio returns and minimize market risk as much as they can.
The tactical asset allocation style of investment is drastically different from various other investment tactics like fundamental analysis and technical analysis. Why? It primarily focuses on the allocation of assets while its secondary focus is on selecting investments. This article will extensively discuss the ins and outs of tactical asset allocation and how individuals can utilize it for their investment strategy.
Tactical Asset Allocation Explained
Many investment strategies focus on some particular asset choices. A tactical asset allocation strategy, however, is quite different. Why? Because its priority is to maintain a favorable mix of various asset types, ensuring that they fulfill the investor’s preferred risk level. In this plan, you have to actively keep an eye on the performance of various asset classes and adjust your allocation.
A tactical investor never determines and sticks with a specific asset mix. Instead, he or she selects the initial blend and waits to analyze its performance. If it does not fulfill their expectations, they made adjustments to cash, bonds, and stock proportions to ensure that they suit their desired returns.
Understanding How This Strategy Works
As discussed earlier, most investors implement tactical asset allocation to arrive at a suitable combination of assets that meats their investment and risk tolerance objectives. If someone selects moderate portfolio allocation, it will look something like this:
- Five percent of cash
- Thirty percent bonds
- Sixty-five percent stocks
People new to this strategy often wonder what it is about this investment style that makes it tactical. Well, in TAA, allocation always changes depending on the expected or current economic and marketing conditions. The investor’s objectives and the marketing and economic conditions, as mentioned earlier, can be underweighted, over-weighted, or neutral-weighted.
A neutral weighted asset performs under the prevailing market conditions.
Overweight assets exceed outperforming market conditions.
These assets indicate low performance.
For instance, think of the five, thirty, and sixty-five allocation we discussed earlier. It is the target allocation of an investor, and each of the assets will fall in the “neutral-weighted” category. Let us assume that there have been changes in economic and market conditions, and stock valuations have become high. Furthermore, a bull market is reaching the maturity stages.
In this situation, the investor is most likely thinking that a negative environment is approaching, and stocks are becoming overpriced. They may then start moving away from risk and get closer to a conservative asset mix like ten percent cash, forty percent bonds, and fifty percent stocks.
In this situation, the investor over-weighted the cash and bonds and underweighted the stocks. This risk reduction may continue in tiny steps as a recession, and a fresh bear market draws closer. The investor might try to be entirely in cash and bonds as the bear market conditions become evident. The asset allocator will eventually consider making some additions to his/her stock positions to get ready for the upcoming bull market.
It is worth noting that tactical asset allocation is vastly different from AMM (absolute market timing) as the method is systematic, deliberate, and slow. On the other hand, AMT mostly involves speculative and frequent trading strategies. You must choose TAA if you are looking for an active investing style that also incorporates buy–and–hold and passive investing qualities as the investors do not necessarily abandon investments or asset types but rather make adjustments to the percentages’ weight.
Tactical Asset Allocation – An Ideal Long-Term Strategy
Financial advisors and investors who utilize tactical asset allocation for investing do so because they think about the big picture. Most of these people support the modern portfolio theory. For those who do not know, this theory backs up the fact that asset allocation has a significant impact on market risk and portfolio returns compared to the proper selection of investments.
You do not need to be an experienced statistician to comprehend TAA’s fundamental premise. Think of an investor who has excellent analysis and research skills. Let us say you have a portfolio containing twenty stocks, and it outperforms or matches S and P 500 Index Funds for multiple years. Most would say it is a good thing.
However, before we jump to conclusions, let us consider another scenario: between 1997 and 1999, several investors outperformed S and P 500, but things were drastically different during the period starting fromJanuary 2000 till December 2009. Why? Because even stable stockportfolios would provide terrible returns, which would be as low as zero percent. What’s more, the most conservative blends of cash, bonds, and stocks would have to outperform these stock portfolios. It proves that asset allocation is arguably the most significant factor influencing overall portfolio performance, particularly in the long run.
Investors could be poor when selecting investments. However, they could be excellent at TAA with consistently high performances compared to fundamental and technical investors skilled at selecting investments.
Comparing Tactical Asset Allocation with Strategic Asset Allocation
In strategic asset allocation, the investors determine target allocations for various assets and rebalance their portfolios. They balance the portfolio to their primary allocations whenever they notice a significant deviation from the original settings. Differing returns from several assets is a big reason why this happens.
What makes SAA different from other allocation models is that the portfolio assets’ combination remains fixed in line with an investor’s profile. Furthermore, the number of assets assigned to real estate, bonds, cash, stocks, etc. are according to each individual’s risk tolerance, financial status, strategies, and goals. Maintaining strategic asset allocation is relatively straightforward. Plus, it also tailor’s to each investor’s profile.
Quite a lot of investors choose the autopilot option after choosing SAA. An initial analysis determines an individual’s strategies, risk tolerance, financial status, and goals. Once the review is over, investors need to put little to no effort into maintaining their asset allocation.
As discussed earlier, tactical asset allocation is entirely different from SAA. Its approach is more flexible as it takes a mid to short-term view. TAA allows you to grasp investment opportunities instantly after they appear in the market. It is more dynamic and provides investors or their advisors the freedom to manage their portfolios to limit losses and maximize profits.
Unlike strategic asset allocation, people who choose SAA need to be highly-disciplined and have a comprehensive understanding of professional judgments, market timing, and other essential elements. Consider acquiring a financial advisor’s help if you do not have the experience to make educated judgments when utilizing tactical asset allocation.
Benefits of Tactical Asset Allocation
While tactical asset allocation has plenty of benefits, let us look at four essential reasons highlight why it is a drastically superior option:
Firstly, every asset class goes through bear and bull markets. A robust TAA strategy can overweight these asset classes that favor investors and underweight out of favor classes.
Secondly, several investors cannot handle the volatility linked with buy-and-hold investing approaches in one or multiple asset classes. Tactical asset allocation can provide diversification to a portfolio whenever it requires it.
Thirdly, from the client-management viewpoint, investors are always clamoring to see whether their portfolio is getting adjusted to its current environment. They need flexibility, along with a tactical strategy capable of providing that. Why? Because it always objectively responds to various trends in the market.
Finally, most markets are becoming global. Therefore, every investor’s portfolio must reflect this global nature. Having adequate flexibility to make investments in various asset classes, which includes real estate, fixed income, commodities, currencies, and international and equities is the only way to achieve that.
Additionally, tactical asset allocation portfolios are quite advantageous when their design and execution is flawless:
Risk mitigation is arguably the best benefit of TAA, mainly when the bear markets are severe. As mentioned earlier, mitigating the decline of a balanced portfolio when prices are rapidly falling is one of the tactical asset allocation’s primary objectives. Reviewing the vast history of bear markets can provide you complete detail regarding the advantages of this mitigation.
Another advantage that makes TAA a superior strategy is the return enhancements after markets realize an unusually high trading level. Tactical asset allocations’ secondary objective is to ensure outperformance. The allocation strategy can achieve this when markets trade in higher concentrations than typically experienced trading levels. Experts refer to this phenomenon as trending. It is essentially the market’s tendency to continue its current form without declining.
Once again, tactical asset allocation is a drastically attractive investment strategy for the occasions when markets are strongly trending while preparing for an extreme bear market. It is particularly true for investors with tax-deferred accounts or any account in the lower tax brackets.
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