Strategic Asset Allocation Definition Example Vs Tactical

Strategic Asset Allocation Definition

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This asset allocation strategy incorporates equities (large-cap, mid-cap, or small-cap), bonds, money market securities, and cash to create a well-balanced portfolio with fixed targets. The target allocations are based on the investor’s investment time frame, risk tolerance, and financial goals. Being a passive investing strategy requiring minimum maintenance, it is widely popular among amateur investors. Needlessly, it is among the strongest portfolio allocation strategies offering maximum rate-of-return at a specified risk level.

Key Takeaways

Strategic asset allocation (SAA) is a long-term investment strategy where asset classes possess a fixed target allocation that is periodically adjusted to balance risk and return. Target allocations are based on investors’ risk tolerance level, financial goals, and available time frame to achieve the objectives. SAA is similar to a buy-and-hold strategy, suitable for a novice, risk-averse investor with a long-time horizon. The major difference between strategic and tactical asset allocation lies in the flexibility of target allocations. Under the tactical strategy, investors can frequently alter the allocations as per market conditions.

Strategic Asset Allocation Explained

Asset allocationAsset AllocationAsset Allocation is the process of investing your money in various asset classes such as debt, equity, mutual funds, and real estate, depending on your return expectations and risk tolerance. This makes it easier to achieve your long-term financial goals.read more strategies assist in maintaining a perfect balance between risk and rewards via investment in diversified asset classesAsset ClassesAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples.read more. SAA is one of the three prevalent portfolio management approaches, besides tactical and dynamic asset allocation.

Under SSA, targets are allotted for asset classes which are maintained through frequent portfolio adjustments. The process begins with investors deciding their portfolio composition and discerning investment disbursement in each asset class like equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company’s balance sheet.read more, cash, and bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more.

Note that equity provides tax benefitsTax BenefitsTax benefits refer to the credit that a business receives on its tax liability for complying with a norm proposed by the government. The advantage is either credited back to the company after paying its regular taxation amount or deducted when paying the tax liability in the first place.read more and greater returns in the long run, while bonds offer safety and stable income. At the same time, cash provides much-needed liquidity. Therefore, bearing in mind their investment objectives, risk tolerance, liquidityLiquidityLiquidity is the ease of converting assets or securities into cash.read more requirements, investment time horizon, tax status, etc., investors select the financial assets to be included in their portfolio.

Target weights are allotted depending on the long-term risk and return expectations from each asset class. Once the final allocation has been made, it is periodically revised or modified to rebalance the portfolio.

This realignment is required because different asset classes in the portfolio will perform at different levels, deviating from the targets in the SAA. Therefore, investors must readjust it on a predetermined schedule (like annually) to reinstate the original allocation.

Examples of Strategic Asset Allocation

Suppose David has a $700,000 portfolio with an SAA of 40% equities, 30% cash, 20% bonds, and 10% foreign stocks. This amounts to target allocations of $280000 for equities, $210000 for cash, $140000 for bonds, and $70000 for foreign stocks.

After a year, equity offers a 10% rate of returnRate Of ReturnRate of Return (ROR) refers to the expected return on investment (gain or loss) & it is expressed as a percentage. You can calculate this by, ROR = {(Current Investment Value – Original Investment Value)/Original Investment Value} * 100read more; cash comes with a 2% return, while bonds and foreign stocks provide a 5% return each. Now, the portfolio bears $308000, $214200, $147000, and $73500 for equities, cash, bonds, and foreign stocks, respectively. So, the total portfolio value is $742,700, with an overall rate of return worth 6.1%.

The portfolio composition is now 41.47% equities, 28.84% cash, 19.79% bonds, and 9.89% foreign stocks. The SAA approach requires David to readjust the asset classes back to their original allocations.

Thus, David has to make the above adjustments to his portfolio to align the asset classes to their targets.

A research study suggests that gains from SAA depend upon elements like long-run inflation, bond or equity returns, and market volatility. The price deviations of assets may affect the mandated mix at times. However, the fund managerFund ManagerA fund manager refers to an investment professional responsible for fund investment strategy formulation and implementation. They collect and invest the money from various investors and create a good variety of managed funds catering to the diverse preferences exhibited by the investors. read more or investor must keep tabs on the portfolio and ensure to restore the original allocation.

Benefits

Usually, this asset allocation strategy has a long investment time frame of 5-10 years. It ensures sustained growth toward a prolonged financial objective, avoiding brief market shifts. Precisely put, it bears a stable mix of financial assetsFinancial AssetsFinancial assets are investment assets whose value derives from a contractual claim on what they represent. These are liquid assets because the economic resources or ownership can be converted into a valuable asset such as cash.read more.

SAA allows investors to exploit the market’s inherent proficiency for maximum gains. It implicates proceeding with the initial plan regardless of ongoing market trends. Nonetheless, investors may change the allocation itself because of alterations in their risk tolerance level or other constraints.

This conventional long-term portfolio managementPortfolio ManagementPortfolio management involves overseeing a set of investments, including securities, bonds, exchange-traded funds, mutual funds, cryptocurrencies, etc., on a personal or professional levelread more approach is customized as per the investor’s financial objectives. As a result, it generates guaranteed profits in a low-risk environment while rebalancing the portfolio to keep up with the dynamic market. One of the major benefits of strategic asset allocation is ensuring investment discipline.

Ideal for Investors

Novice buy-and-hold investors with a long investment time horizon who prefer a hands-off technique choose SAA to attain long-term monetary gains. Investors with a low risk appetiteRisk AppetiteRisk appetite refers to the amount, rate, or percentage of risk that an individual or organization (as determined by the Board of Directors or management) is willing to accept in exchange for its plan, objectives, and innovation.read more follow this strategy to preserve and appreciate their capital over a long period of time.

This strategy contrasts with tactical asset allocation, wherein experienced investors actively manage their investments to achieve short-term commercial profits. Sometimes, financial executives employ a mixture of both asset allocation strategies to boost the security and adaptability of their finances.

Strategic Asset Allocation Definition Example Vs Tactical