We’ve talked a lot about asset allocation on this platform. It’s my preferred method of investing and is often the one I recommend to my clients. There are different types of asset allocation, though. Tactical and strategic. What’s the difference between strategic and tactical asset allocation?
Before we explore the difference between those two, we should define what asset allocation is.
Asset allocation is a simple, but effective approach to investing your money. It takes into account your risk tolerance, investment objective, and time horizon (also known as suitability).
Using those three pieces of information, you divvy up capital to three (sometimes more) asset classes. Those are stocks, bonds, and cash. Other asset classes that can be included in your allocation include precious metals (i.e. gold and silver) and real estate.
For example, if someone has a moderate risk tolerance, an investment objective of using those funds for retirement, and a long term time horizon, an adequate asset allocation could be 60/30/10. 60% stocks, 30% bonds, and 10% cash.
The goal is to balance the risk/reward dynamics in a way that’s comfortable to you as the investor, using those three suitability items as the barometer.
What is strategic asset allocation?
Strategic asset allocation uses a long term approach. Uses your risk tolerance, investment objective, and time horizon to create the optimum asset allocation that balances risk and reward to fit the above criteria.
What is tactical asset allocation?
Tactical asset allocation uses a short to mid-term approach. Requires more flexibility as you will move in and out of securities as they fall in and out of favor. Strong discipline and understanding of markets are required to utilize a tactical approach.
The difference between strategic and tactical asset allocation
For the everyday investor, strategic allocation makes the most sense. It accomplishes what you’d want in any portfolio – it balances the risk and reward, and creates a portfolio that maximizes return potential while minimizing any inherent risks tied to those asset classes. It’s a “hands-off” approach to investing.
For a more experienced investor that doesn’t mind putting in the time and effort required to analyze and understand the market, trends, etc. tactical asset allocation makes more sense. Proceed with caution, however, as market timing can be very risky.
There are two key differences between strategic and tactical asset allocation. Tactical allocation requires more work, more knowledge, and more experience. Tactical allocation also requires the investor to be more disciplined and more tolerant to risk.
Additionally, tactical allocation takes more of a micro view of economics and the markets. Macroeconomists and strategists view investing from 30,000 feet. Tactical investors look at capsize (the size of a company based on shares outstanding and share price), industry, geographic location, etc. What’s performing well, what are the trends, what industry, location, etc. is likely to outperform in the near term.
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