When it comes to asset allocation, there’s more than one strategy you can follow. Tactical asset allocation is a moderately active approach to portfolio management that focuses on keeping pace with market trends. It’s all about making adjustments to your asset mix to capitalize on individual stocks or market sectors that are performing well, while still managing risk. If you’re interested in finding a way to maximize rewards for the short- or mid-term, here’s what you need to know about tactical asset allocation.
Tactical Asset Allocation Defined
A tactical asset allocation is a market-based approach to managing your investment mix. This active strategy hinges on keeping track of market trends to find opportunities to capture the best returns possible. The end goal is to maximize performance in your portfolio, while still keeping a broader asset allocation.
In that sense, it’s similar to strategic asset allocation. This allocation strategy involves choosing a target mix of investments, say 60% stocks and 40% bonds, and rebalancing periodically to match up with those numbers. With tactical asset allocation, you choose your target asset allocation when setting up your portfolio. But the difference is that you may change your allocations temporarily to cash in if a stock or sector takes off.
Once you get the returns you want for the short-term and the momentum from a particular stock or sector wears off, you go back to your original baseline asset allocation. For example, you might see that a particular tech stock is doing well so you decide to buy in while prices are rising but are not too expensive. That shifts your allocation from 60% stocks to 70%. A few months later once the stock’s price levels off, you decide to sell it for a gain, adjusting your allocation in the process to its default parameters.
That’s tactical asset allocation at work. With strategic asset allocation, you’d be more concerned with keeping your portfolio at your original target. Whether a particular stock has the potential to do well would be less important than making sure you’re not getting over-weighted toward stocks or bonds, based on your target.
Tactical Asset Allocation Pros, Cons
Like any other investment strategy, there are things to like and potentially dislike about tactical asset allocation.
Pros of tactical asset allocation
This strategy could help you to realize significant short-term gains if a tactical move to buy into a stock or sector pays off. You may achieve better returns over time versus sticking with a strictly strategic asset allocation policy. And you have flexibility in deciding whether to try to get in on a particular market trend or ignore it.
For example, changing economic conditions could create market opportunities. Rising or falling interest rates, shifts in inflation and whether the economy is booming or on the verge of a bust can all play a part in influencing market trends. A changing interest rate landscape, for example, could offer an opportunity to expand – or contract – the bond portion of your portfolio.
At the same time, tactical asset allocation is a way to keep your cool when emotions threaten to take over. By being tactical with your approach, you can avoid biases that trigger activities such as panic selling, which can be detrimental to your portfolio returns over time. Rather than bailing out on stocks completely when it seems as if a market downturn is coming, you could take a more optimistic approach in looking for opportunities to buy stocks at a bargain.
Cons of tactical asset allocation
On the other hand, tactical asset allocation requires you to do a little more work compared to strategic asset allocation. With strategic allocation, for example, you may only rebalance your portfolio once per year. A tactical approach means you have to be more tuned into the market so you’re able to spot opportunities as they come along. It’s not as active a strategy as dynamic asset allocation but it may not appeal to an investor who wants to be largely hands-off.
That also raises another concern, which is cost. Depending on what you’re trading and how often, tactical asset allocation could trigger more commission fees. Keeping track of fees is important because the more you pay in trading fees, the less of your returns you get to keep. For that reason, it’s important to consider the return potential when using tactical allocation to make investment decisions.
Tactical Asset Allocation vs. Dynamic Asset Allocation
Dynamic asset allocation is an even more active approach to managing a portfolio. Rather than making the occasional move to change your allocation to reap gains, investors who use dynamic allocation are constantly adjusting their asset mix to fit the market. The overall objective is to reduce your position in asset classes that are underperforming at any given time while increasing your position in asset classes that are performing well.
With this approach, you’re aiming to invest in the winners to get the best returns while minimizing your downside by avoiding the losers. There is no set asset mix percentage you’re shooting for. For example, it wouldn’t necessarily matter to a dynamic asset allocation investor whether they held 60% stocks and 40% bonds in their portfolio.
Similar to tactical allocation, one of the biggest challenges with this strategy is cost since you’re trading more frequently. Not to mention, it requires you to keep your thumb on the pulse of the market, which may not appeal to you if you don’t have the time or capacity to constantly monitor stock movements.
The Bottom Line
If you understand strategic asset allocation and dynamic asset allocation, you could say that tactical asset allocation is a way to split the difference between them. Essentially, it can be a way to get the best of both worlds: keeping your portfolio aligned with a target asset mix, while occasionally benefiting from short-term market movements. It’s an option to consider as you determine the best way to manage your investments now and for the long-term.
Asset Allocation Tips
- Consider talking to a financial advisor about your options for an asset allocation strategy. Finding a financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s matching tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
- Deciding on a tactical asset allocation strategy requires knowing what percentage of your money you have in various asset classes. The SmartAsset asset allocation calculator can give you a sharper picture of how your assets are apportioned and an estimate of their prospects.
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