Asset allocation is all about having the right mix of
assets. It’s all about having enough stocks, bonds, and even real estate on
your portfolio. It’s a dynamic process that plays a crucial role in finding
your portfolio’s overall risk and return.
Therefore, it’s important that the asset mix is in line with
your goals at any point in time. Below, we list down different strategies for establishing
asset allocations. Check them out.
Strategic Asset Allocation
This method establishes and follows the “base policy mix,”
which is a proportional combination of assets based on expected rates of return
for each asset class.
For instance, if stocks have historically returned 10
percent per year and bonds have returned 5 percent per year, a mix of 50
percent stocks and 50 percent bonds would be expected to return 7.5 percent per
year.
Constant-Weighting Asset Allocation
Strategic asset allocation in general implies a buy-and-hold
strategy, even as the shift in values of assets triggers a deviation from the
initially established policy mix.
And because of this, you might want to choose a constant-weighting
approach to asset allocation. With this style, you regularly rebalance your
portfolio.
For instance, if one asset is seen slumping in value, you
would purchase more of that asset, and if the asset’s value is increasing, you
would sell it.
There are really no strict rules when it comes to timing
portfolio rebalancing under strategic or constant-weighting asset allocation.
On the other hand, it is generally advised that the
portfolio is rebalanced to its original mix when any given asset class moves more
than 5 percent from its original value.
Tactical Asset Allocation
Over the longer haul, a strategic asset allocation strategy
may not seem flexible. As a result, you may find the need to occasionally
engage in short-term, tactical deviations from the mix to take advantage of
unusual or exceptional investment opportunities.
This kind of flexibility adds a market-timing component to
the portfolio, allowing you to participate in economic conditions more favorable
for one asset class than for others.
Tactical asset allocation is somehow a moderately active strategy, since the broader strategic asset mix is returned to when the target
short-term profits have been achieved.
This strategy demands some discipline, as you must first be
able to notice when short-term opportunities have lost their steam and then
rebalance the portfolio to the long-term position.
Dynamic Asset Allocation
Another active asset allocation strategy is dynamic asset
allocation, with which you frequently tweak the mix of assets as markets
increase and decrease, and as the economy strengthens and weakens.
Using this strategy you sell assets that are declining and purchase
assets that are increasing. Of course, this makes the dynamic asset allocation strategy
the exact inverse of the constant-weighting strategy.
For instance, if the stock market is showing weakness, you
sell the stocks as you expect further weakness in the future. And if the market
is showing strength, you buy more as you expect further gains.
Insured Asset Allocation
Using an insured asset allocation strategy, you establish a
base portfolio value under which the portfolio should not be allowed to drop.
As long as the portfolio attains a return that lies above
its base, you exercise active management using analytical research, forecasts,
and judgment. You also decide what securities to buy, sell, and hold, with the
goal of increasing the portfolio value as much as possible.
If, on the other hand, the portfolio should ever slip down
and under the base value, you then invest in risk-free assets like Treasury bills
so that the base value becomes fixed.
Insured asset allocation may be suitable for risk-averse
investors who want a certain level of active portfolio management but
appreciate the security of setting up a guaranteed floor below which the
portfolio is not allowed to decline.
For example, if you wish to establish a minimum standard of
living during retirement, you might search for an insured asset allocation
strategy ideally suited to your management goals.
Integrated Asset Allocation
With this asset allocation model, you consider both your
economic expectations and your risk in establishing an asset mix.
While all of the above-mentioned strategies take into
account expectations for future market returns, not all of the strategies
account for all strategies, accounting not only for expectations but also
actual changes in capital markets and your risk tolerance.
Integrated asset allocation is bigger asset allocation
strategy. Bear in mind, however, that it cannot include both dynamic and constant-weighted
allocation, since, quite obviously, you wouldn’t be able to implement the two strategies
along with one another.
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