What are the important elements of strategic asset allocation?

Strategic asset allocation is one method of allocating your investment. Asset allocation, in general, is an investment method that aims to balance risk and return. Investors allocate their assets based on their risk tolerance, return goals, and long-term investment plans. Each asset class has its own risk level and return rate. Hence their allocation varies from each other. 

In this article we will explore the strategic asset allocation in the following:

1. What is strategic asset allocation?

Strategic asset allocation is a long-term investment portfolio strategy where investors decide on an allocation method and stick to it for a long time rather than reacting to current market conditions. It is based on modern portfolio theory and is used to diversify investment portfolios to generate higher returns with minimum risk. The investor allocates his money to various asset classes, like stocks, bonds, and cash, and only rebalances the portfolio when an asset class does well. Strategic asset allocation is similar to a buy-and-hold scheme because investors decide on a plan and stick to it for a long time and only modifies it to rebalance it to its original allocation strategy. For example, if your target asset allocation is 70% equities and 30% bonds, and your investment, in reality, consists of 80% equities. Strategic asset allocation would require you to sell the extra 10% in equities and spread the profits in the lower performing asset class (like bonds, for example) even if your equities perform well. This is because your equity target is 70%, and hence it should remain in its original percentage. This is also called a contrarian approach

2. Things to consider for strategic asset allocation

Strategic asset allocation considers the following factors which are intertwined with one another:

  • Risk tolerance 
  • Return goals
  • Investment time horizon 

Both Risk and Reward goals have a major impact on strategic asset allocation. The more risk you can tolerate, the higher returns you can target. The same goes for lower risk tolerance and lower returns. If your objective is to maximise your profits for the long term, you can allocate more of your investment in high-risk and high reward asset classes like stocks. Investors with long-term targets are more like to invest in aggressive asset classes because the investor has the time to rebalance the risks with the rewards over the long term. The investor can even hold on during bad market conditions and need not cash out.

3. Strategic asset allocation vs tactical asset allocation

The comparison between strategic and tactical asset allocation often comes up due to their polar differences. Strategic asset allocation is more passive in investment management, while tactical asset allocation has an active portfolio management approach. Strategic asset allocation is for you if you prefer the following as your investment objectives:

  • You prefer to be hands-off of your investment and not buy-sell regularly. You only buy or sell when you need to rebalance your portfolio
  • You prefer only to buy assets that you want to keep for longer. This effectively reduces your transaction fees too
  • If you do not need the money for a long time - in that case, you can hold it for a long time and recover from the potential market downfall
  • Suppose you feel that you are not experienced enough to opt for active investments. In that case, strategic asset allocation will force you to stick to your original plans without exposing you to emotional trading

Tactical asset allocation strategy is for you if you prefer the following:

  • If you want to have more control over your investment decisions
  • If you want to trade more often to make greater profits from the market conditions. This will mean making more transactions and incurring higher fees
  • If your investment goals are for a short term
  • You feel confident enough to trade actively if you know how to utilise current market conditions more effectively to your advantage

It should be noted that most investors combine strategic and tactical asset allocation to take advantage of the investment opportunities for an increase in portfolio growth and to balance out the level of risk.

Strategic asset allocation is ideal for anyone who is looking to be free from investment headaches. This type of investor wishes to buy few times a year and hold on to it until he is required to change it back to his original target. This investor may have the same risk tolerance their whole life, and it will rarely change on the market volatility. If you are this investor but unsure how to allocate strategically, better consult with a financial advisor to create an appropriate investment portfolio.

Last update: 06/08/2021

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