Strategic asset allocation is a portfolio strategy. The investor sets a target allocations for various asset classes. The portfolio is then rebalanced periodically. Your strategic asset allocation is a method of aligning your portfolio with your financial goals. It’s the practice of balancing potential growth with risk and volatility.
Asset allocation strategies are a tactic for fine tuning your investments. Which can help focus your investments towards long-term goals. This might include the intention to become financial independent and retire early (F.I.R.E) It might also be centred on short-term goals such as maintaining a retirement portfolio.
You can also tailor your strategic asset allocation to be more hands off. This can reduce your emotional risk and negative impact as an investor. Alternatively, you can set it up to be a more hands-on to make the most of investment opportunities. This is tilting more towards tactical asset management.
To optimise your strategic asset allocation you need to understand your investment goals. Do you want to minimise your risk of losing money in the short-term or to maximise growth in the long-term? This dictates which assets should be included in your allocation.
*Disclaimer: This is not financial advice and you are responsible for your own financial decisions. When investing capital is at risk. This article also contains affiliate links.
What Investment Assets Can Form Your Strategic Asset Allocation?
When you invest you can buy different assets. There are government bonds, cooperate bonds, mutual funds, index funds, stocks and real estate. There are also more complex financial instruments and derivatives.
All these different assets have different functions, average returns and ‘risk’ attached to them. Government bonds are deemed low risk as it’s unlikely a government will default on their loans. Although, there is never zero risk and even recently the likes of Russia have defaulted on their debts.
By contrast, stocks are associated with high risk because they are the most volatile. One year they might be up 50% the next they might be down 50%. You just never know and despite what people say, you can’t time the market.
< Explore: How Long Until You Can FIRE: How To Track Your Income, Expenses And Investments
Your strategic asset allocation should vary depending on your financial goals. Where are you are on your investment journey? The strategic asset allocation of someone in their 20s should not be the same as someone in their 50s. The latter maybe 5 years away from retirement the former may have a 30 year investment horizon. One needs to preserve capital and the other to chase growth.
This is not to say that it’s necessary for someone in their 50s or 60s to entirely minimize risk. Removing all stocks from their portfolio in exchange for government bonds isn’t optimal. Some degree of stocks in retirement can improve the chances of portfolio survival and growth. Equally, someone in their 20s may still wish to preserve some capital. It can be an crucial buffer against disastrous economic circumstances, such as high unemployment.
< Explore: The Truth About Saving For Early Retirement In Your 20s >
Why Is Strategic Asset Allocation Important?
Strategic allocation is important from the perspective of having clear investment goals. You wouldn’t want to invest into a 100% stocks if you think you might need that money in 5 years for a house deposit.
You also don’t want to stretch yourself and need this money in 5 years. This sets you up to fail. That’s because you risk having to sell your assets for less than you paid for them if the market crashes. It’s crucial to stay solvent and persevere through economic and market volatility.
When the market is in a bull market run you feel confident on putting more money into the market. It can be easy to forget the bear markets often coincide the recessions and difficult economic circumstances.
You might feel you need more cash right now, because of the high cost of living. At the same time, stocks have fallen over 20% in the last 6 months. This means indices such as the S&P 500 have now entered bear market territory. This will have many investors wishing they had more liquidity and a less volatile asset allocation.
Maintaining a highly volatile asset allocation in times such as this can make sense. It’s just important to know the volatility you can tolerate. This means having a clear picture of your overall financial health. Minimising your costs, automating your finances and having a financial plan are all crucial when the economy is crashing.
< Explore: How Long Will The Bear Market Last? What You Need To Know About Bear Markets >
How To Set Up Your Strategic Asset Allocation
You might be reading this in your early 20s with £5,000 of savings that you want to invest. You might have decided that you are comfortable with a little loss in the short-run for better long-term gains. You therefore conclude that you want a portfolio that is based on holding 80% stocks and 20% bonds.
This means you’d be investing £4,000 in stocks and £1,000 in bonds. A year later you stocks may have increased by 20% to £4,800. By contrast, you bonds have grown by 0%. As a result, you portfolio is now 82.75% stocks and 17.25% bonds.
(This leads many investors to chase returns by going 100% stocks. Which is not a good or bad things, it just depends on your investment plan.)
Assuming you want to stick with your strategic asset allocation, your assets are now unbalanced and need rebalancing. This means you’d need to sell some of your stocks and buy more bonds. If you’re dedicated to your asset allocation strategy, you’ll have to constantly buying and selling to maintain the balance.
This is the case for many investors who buy to separate funds and manage it themselves. For example, you could buy the Fidelity Index World Fund and BlackRock Corporate Bond 1-10 Year Fund.
However, you can simplify this by investing into a fund that does this for you. For example, the Fidelity Multi Asset Allocator Adventurous Fund. In fact you can download the full list of 5 Balanced Funds or 5 Retirement Based funds to give you some more ideas.
How To Determine Your Asset Allocation
There is over-simplified rule of thumb used to help people decide on their strategic asset allocation. It suggest your asset allocation should be based on your investment time-horizon. With your asset allocation weighted accordingly. The closer your are to retirement, the more defensive assets you hold.
The calculation dictates you should hold the percentage of stocks that is equal to 100 minus your age. So if you’re 40, you should hold 60% of your portfolio in stocks and 40% in bonds. By the time you are 60 you would have 40% held in stocks and 60% in bonds.
It’s not a bad rule on thumb but it’s not sensitive to life expectancy, retirement age or portfolio success rate by asset allocation data. It does provide an easy to understand method of adjusting your strategic asset allocation. As it only depends on the amount of time you have to invest.
< Explore: What is an ETF And How Does It Work: Simple Ways To Buy A Complex Bundle Of Assets >
Strategic Asset Allocation Is About Emotional Management
As a data analyst, I follow the evidence wherever it may lead. I’d like to think that by the time I get to retirement age, I’ll transition to 55% stocks and 45% bonds asset allocation. That’s because all the data I’ve seen suggests this is optimal for portfolio growth and survival rate.
Recently, I’ve been helping my Mum make decisions about her investment portfolio. She is 100x more risk averse than I am and want’s to hedge against any kind of expected or unexpected volatility. Taking a less aggressive approach to buying stocks is more suitable from an emotional perspective.
She does not want to have to ride out any volatility in the markets or see her investments go down. In fact, she is hesitant to invest at all but in this era of rising inflation (circa 9%), you can’t afford not to.
This means buying into a fund that can continuously rebalance towards defensive assets. Which might consist of between 60% to 80% of the portfolio. This portfolio is going to be based on more fixed income assets, cooperate and government bonds. This is why I also created a list of 5 defensive funds for her to review.
The point is, you need to be comfortable with the potential of your risk class compared to the potential for total loss.
< Explore: How To Invest To Beat Inflation And Interest Rate Rises
Trackbacks/Pingbacks