What Is Tactical Asset Allocation and How Does It Help Your Investment Strategy?

Tactical asset allocation (TAA) is the act of balancing a portfolio’s mix of stocks, bonds and cash in order to maximize returns within a particular risk tolerance. TAA is more focused on what percentage of a portfolio is in equities, bonds and cash instead of the specific securities held.

Tactical asset allocation is more active than traditional buy and hold in that, traditionally, tactical asset allocation necessitates monitoring the performance of an asset mix and adjusting the proportions to maintain a particular balance of risk and returns. The method is sometimes referred to as market timing and may be viewed as an alternative to strategic asset allocation.

Not Without Its Criticisms

There are many analysts who have performed deep dives on TAA funds, as well as comparisons between these funds and balanced index portfolios and passive investing strategies. Tactical allocation funds tend to have high expense ratios due to the frequency of trades for rebalancing. They also have a history of underperforming benchmark indexes, even taking into account risk-adjusted performance.   

Questions can also arise over when and how decisions regarding asset mixes are made. Some investors may question decisions made by fund managers who are basing asset allocation decisions on their own predictive interpretation of quantitative metrics. Those formulae and the resulting predictions aren’t necessarily infallible.

Despite frequent criticism of tactical asset allocation funds, there are many investors who value risk avoidance over the potential gains represented by more traditional equity indexes.

Strategic Asset Allocation Versus Tactical Asset Allocation

Strategic asset allocation is the more traditional approach often exemplified by the basic options in a 401(k). Investors pick their asset and fund allocations and generally stick with that allocation. They then rebalance periodically when differing rates of return result in deviations from their preferred allocation.

Strategic asset allocation decisions tend to be based on risk tolerance, time until retirement or underlying investment objectives. Strategic asset allocation can be described as a traditional buy-and-hold approach to investment, while tactical asset allocation requires more active and frequent intervention.

In many cases, investors who adhere to strategic asset allocations stick with their allocations for many years or even decades. They may only adjust their allocations when nearing certain major life changes, like retirement.

Which Method Can the Average Retirement Saver Use?

This is one of the key differences between tactical asset allocation and strategic asset allocation. Every investor can engage in strategic asset allocation on their own. They may even own tactical asset allocation funds in their strategic allocation mix.

Tactical asset allocation is harder for the average investor to do because it’s not a set-it-and-forget-it strategy. TAA requires significant knowledge of the market and the current riskiness of asset classes. Implementing your own tactical asset allocation strategy is labor intensive and may generate significant brokerage fees.

What’s an Example of a Strategic Asset Allocation?

A young person may maintain a strategic asset allocation of:

• 70 percent equities
• 20 percent fixed income
• 10 percent cash

If their equities grow by 10 percent over a year while bonds only grow two percent, the actual allocation of their investments will become imbalanced. At that point, they might go into their investment account and rebalance their allocation to restore the 70/20/10 split.

A person nearing retirement may have a strategic asset allocation that looks more like:

• 20 percent equities
• 60 percent fixed income
• 20 percent cash

This mix of assets reduces the risk exposure of equities, but also reduces the investor’s growth potential.

What Are Fixed-Income Securities?

Bonds, like government bonds and corporate bonds that pay out regular interest payments and full principal repayment at maturity, are considered fixed-income securities. An investment that pays changing returns is considered a variable-income security.

Bonds aren’t the only example of fixed-income securities. Others include money market accounts and CDs.

Because variable-income securities represent a greater risk to investors, they garner higher returns than safer fixed-income securities.

What’s the Right Investment Strategy for Your Portfolio?

Whether you’re nearing retirement or just want to know how you can invest smarter, Fullerton Financial Planning can help. Our Phoenix and Tempe retirement planning and investment management professionals are committed to helping clients discover the right balance of risk mitigation and portfolio growth.

Call us at (623) 974-0300 to speak with a financial advisor today.