A well-rounded investment strategy often holds more than one type of asset. Whether it’s bonds, cash, equities, or cryptocurrencies, the diversity of investments across different asset classes defines your asset allocation.
For investors, it’s crucial to understand the two main approaches to asset allocation: strategic and tactical. While the two have definitive differences, effective implementation continues to challenge even seasoned investors.
In this article, we dive deep into the strategies’ definitions, key features, and best practices to help you make informed decisions.
Understanding Asset Allocation
Because resources are always finite, it is important for investors to be savvy with regards to how they distribute their investments across different asset classes, including but not limited to equities, bonds, real estate, and cryptocurrencies. Each asset class performs differently under various market conditions. For example, bonds are viewed as a stable investment but have historically lower expected returns than a more volatile asset like cryptocurrencies.
When constructing your portfolio, it is important to consider the following factors:
- Financial goals: What are you looking to achieve?
- Risk tolerance: How much risk can you bear?
- Market knowledge: How well do you understand specific asset classes
Distinct market knowledge plays a key role here. It is often an underrated factor when deciding your asset allocation. If an investor has deep market knowledge in a specific industry, it would be advantageous to use that as one assembles their portfolio mix.
Warren Buffett, Chair and CEO of Berkshire Hathaway, has always preached the importance of familiarity and investing in what you know because “if you get to know even about a relatively small area more than the other people do, and you don’t feel the compulsion to act too often, you just wait till the odds are strongly in your favor.” He continues, “if you know even one thing very well, it’ll give you an edge at some point.”
Ultimately, asset allocation is a cornerstone of long-term investment strategies. It helps investors navigate market uncertainty by setting a clear and rational plan aligned with their financial goals.
What is Strategic Asset Allocation
Strategic asset allocation (SAA) offers a long-term, disciplined approach to investing. Creating a strategic asset allocation plan involves setting a target proportion for each asset class while maintaining these percentages through market volatility, regardless of short-term market fluctuations.
A Strategic Asset Allocation plan involves:
- Clearly defined long-term goals
Whether retirement, growth, or wealth preservation, defined long-term goals create a solid foundation to align your portfolio.
- Risk management
With the help of these clearly defined goals, investors avoid over-exposure to a single asset class, equity, or bond, protecting their capital from volatility and large market swings.
- Careful monitoring and rebalancing
A strong strategic asset allocation plan requires an investor to regularly rebalance their portfolio and ensure that it stays aligned with their predetermined allocations. Investment professionals recommend rebalancing a portfolio at least once every 6 to 12 months or when allocation percentages drift more than 5%. Consider market conditions and allocation percentages during this process.
The Pros and Cons of Strategic Asset Allocation
What is Tactical Asset Allocation
While strategic asset allocation focuses on closely following a long-term path, tactical asset allocation (TAA) describes a more dynamic approach. It allows investors to capitalize on short-to medium-term market opportunities to create a profit by temporarily deviating from their long-term asset allocation.
Tactical Asset Allocation (TAA) presents opportunities for:
- Flexibility
TAA allows investors to adjust their portfolio based on current market conditions. For example, tactical investors might increase their ETH allocation during a bull market driven by institutional investment.
- Potential for higher returns and risk mitigation
By seizing short-term opportunities, TAA can enhance portfolio performance. For example, if you hear news of a regulation that may negatively impact crypto prices, you could temporarily move your capital from crypto to stocks or bonds.
While strategic and long-term asset allocation is a relatively passive investment strategy, tactical asset allocation allows investors to take on a more active role in their investment strategy.
That said, a successful TAA strategy requires investors to have a deep understanding of market trends and asset behavior, while having the cool composure required to make timely decisions.
The Pros and Cons of Tactical Asset Allocation
Effectively Implementing Both
Strategic asset allocation and tactical asset allocation are not entirely separate strategies, they work hand-in-hand with each other and work best when integrated as an overall strategy. While SAA focuses on long-term planning, TAA allows investors to deviate temporarily from their strategic plan with the intention of returning to their baseline allocations once the opportunity has passed.
Best Practices for Combining SAA and TAA:
- Balance: Use SAA as a baseline and incorporate TAA judiciously when opportunities arise.
- Reevaluate Regularly: Continuously monitor your portfolio to ensure it aligns with your long-term goals, while benefiting from tactical adjustments.
- Stay Informed: Understand market trends and their potential impact on your portfolio.
By balancing these approaches, investors can achieve long-term objectives while capitalizing on short-term trends.
Final Notes on Asset Allocation
Proper asset allocation is a foundational aspect of any successful investor’s strategy. When combined, strategic asset allocation and tactical asset allocation creates a balanced means to maximize long-term gains while minimizing risk.
Though anyone can set their portfolio’s asset mix, even the most savvy investors often have difficulty maintaining their desired portfolio mix, maximizing profits, and making rational investment decisions across all asset classes - especially in highly dynamic markets like cryptocurrency.
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