What is tactical asset allocation?

Definition and Example of Tactical Asset Allocation

How Does Tactical Asset Allocation Work?

Tactical Asset Allocation for Long-Term Growth

How to Use Funds for Tactical Asset Allocation

Definition and Example of Tactical Asset Allocation

The tactical asset allocation strategy focuses on maintaining an optimal mix of asset types to suit the desired risk level. This requires monitoring the performance of different asset classes and adjusting portfolio allocations accordingly.

Instead of deciding on an asset mix and sticking to it, you will select an initial mix. You will then wait to see if it performs as expected. If it does not, you will adjust the ratios of stocks, bonds, and cash to better match your desired returns.

How Does Tactical Asset Allocation Work?

By using tactical asset allocation, you can achieve a mix of solid assets that fits your risk tolerance and goals. For example, if you choose to allocate a moderate portfolio, it may have a target of 65% stocks, 30% bonds, and 5% cash.

The part that makes this investment style tactical is that the allocation will change depending on prevailing (or expected) market and economic conditions. Depending on these conditions and your goals, the allocation to a particular asset (or more than one asset) can be weight-neutral, overweighted, or underweighted.

For instance, let’s look at the 65/30/5 allocation mentioned above. This is the target; all assets are “weight-neutral.” Let’s assume that market and economic conditions have changed; stock estimates have become relatively high, and there seems to be a mature bull market. At that time, you might think that stocks are overpriced and that a negative environment is close. You may then decide to start taking steps away from market risk and towards a more conservative asset mix, such as 50% stocks, 40% bonds, and 10% cash.

In this scenario, you have lower-weighted stocks and higher-weighted bonds and cash. You will continue to reduce risk in steps if it seems that a bear market and recession are approaching. You may try to have your investments nearly in bonds and cash by bear market conditions. At that time, you will consider reallocating your positions in stocks in preparation for the slow ascent that represents a bull market.

Tactical asset allocation can be used with mutual funds in retirement accounts such as 401(k) and 403(b) accounts. Employees may have the option to rebalance their portfolios. Those who choose to actively manage their investments can employ the tactics outlined here.

It is important to note that tactical asset allocation is different from market timing, as this method is slow, deliberate, and systematic. Market timing, on the other hand, often involves more frequent trading and speculation in an attempt to catch dips.

Tactical asset allocation is an active investment style that combines passive investing and asset retention. It is not necessary to abandon asset types or investments but to change the weights or ratios to match market changes.

What Does This Mean for Individual Investors?

Those who choose to invest using tactical asset allocation look at the big picture. They are more likely to agree with modern portfolio theory, which states that asset allocation has a greater impact on portfolio returns and market risk than the selection of investments.

You don’t have to be a statistician to learn how tactical asset allocation works. For example, let’s say you are a basic investor. You have done well with research and analysis. Perhaps you have a portfolio consisting of 20 stocks that have either matched or outperformed the S&P 500 index funds for three consecutive years. It seems you are managing your portfolio quite well.

However, you might want to consider this scenario: During the three-year period from the beginning of 1997 to the end of 1999, many people found it easy to outperform the S&P 500 index.

And with
During the decade from January 2000 to December 2009, even a strong stock portfolio had a return of 0%. It would perform worse than even a more conservative mix of stocks, bonds, and cash.

What if you were bad at picking investments but good at tactical asset allocation? You might perform better than those who are good at selecting investments but have poor timing in asset allocation.

The point is that bull and bear markets can last for years, giving investors false impressions of their abilities. Since asset allocation allows you to adjust part of your portfolio’s performance to match market conditions, some consider it the biggest factor in overall portfolio performance over the long term.

How to Use Funds for Tactical Asset Allocation

Tactical asset allocation works well with index funds and exchange-traded funds (ETFs). Again, the focus is primarily on asset classes and how they perform in specific market conditions. For example, if you invested in mutual funds, you could choose stock index funds, bond index funds, and money market funds instead of building a portfolio of individual securities. The specific types of funds and equity classes can also be simple, such as large-cap stocks, foreign stocks, and small-cap stocks or sector funds and ETFs.

If you choose sectors for your tactical asset allocation strategy, you may select sectors that you believe will perform well in the near to medium term. For example, you may believe that real estate, healthcare, and utilities may yield the best returns over the coming years, so you might buy ETFs within those sectors.

Here’s an ideal portfolio using index funds and exchange-traded funds:

65% Stocks

• 25%: S&P 500 Index
• 15%: Foreign Stocks (MSCI Index)
• 10%: Russell 2000 Index
• 5%: Sector ETF for Technology
• 5%: Sector ETF for Healthcare
• 5%: Sector ETF for Utilities

30% Bonds

• 10%: Short-Term Bond Index
• 10%: Inflation-Protected Securities (TIPS) Index
• 10%: Intermediate-Term Bond Index

5% Cash

• 5%: Money Market Fund

By using tactical asset allocation, you can increase or decrease the percentages in certain areas to reflect your expectations for near-term conditions. You can also choose to change other sectors like energy (natural resources) and precious metals.

Source: https://www.thebalancemoney.com/what-is-tactical-asset-allocation-2466851