What Is Strategic Asset Allocation?

Drazen_ / iStock.com

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

Asset allocation is the practice of dividing your investment portfolio across multiple different asset classes. It requires weighing the risks and rewards of each asset based on your situation. Each person’s asset allocation may look a bit different because of their unique financial goals, risk tolerance and time horizon.

There are several strategies you can take when deciding on your asset allocation, one of the most popular of which is strategic asset allocation. It’s a favorite among long-term, buy-and-hold investors and has some key benefits.

What Is Strategic Asset Allocation?

Strategic asset allocation is a long-term investment strategy that involves setting a target allocation based on your unique situation and maintaining it over the long term, regardless of short-term market events. The portfolio is periodically rebalanced to maintain its original asset allocation. The asset allocation may be adjusted over time, but it’s done based on the individual investor, not based on the market.

Strategic Asset Allocation Factors

When you build a portfolio using strategic asset allocation, you generally rely on three key factors to determine your asset allocation:

• Financial goals: Your specific investment objectives can guide your portfolio construction. For example, you may invest differently depending on the purpose of the money, whether it be retirement, your child’s college savings or something else.
• Time horizon: Generally speaking, the longer your time horizon (meaning, the more time before you need the money), the more risk you can afford to take in your asset allocation. Meanwhile, a shorter time horizon may warrant a lower-risk portfolio.
• Risk tolerance: Each person has a different risk tolerance. Someone with a high-risk tolerance may feel comfortable with more volatility in their portfolio, while someone with a low-risk tolerance may want a lower-risk portfolio with lower potential returns.

Strategic Asset Allocation Example

Suppose you’re building your asset allocation for your retirement 20 years from now. You have a moderate risk tolerance, and you decide to put 60% of your money into stocks and the remaining 40% into bonds.

Several times per year, you sit down to rebalance your portfolio, getting it back to your desired 60/40 split. As you get closer to your retirement year, you may adjust your asset allocation to include a smaller percentage of stocks and a higher percentage of bonds or cash equivalents.

For example, a decade later, you may decide to invest only 50% in stocks and put the remaining 10% in cash equivalents or other low-risk investments.

The market experiences fluctuations during this time, but you don’t factor those movements into your investment strategy, nor do you adjust your asset allocation because of them.

Benefits of Strategic Asset Allocation

Strategic asset allocation helps you build a diversified investment portfolio that prioritizes long-term returns while weathering short-term market movements.

In the short term, strategic asset allocation helps you avoid investment losses due to short-term market fluctuations and reduces your overall risk. You don’t have to worry about correctly timing the market like a day trader does, meaning you’re less likely to experience day-to-day losses. Additionally, because you aren’t frequently buying and selling assets, you can minimize your capital gains tax liability.

In the long term, strategic asset allocation provides stability and helps you take advantage of the stock market’s long-term growth. Additionally, considering the vast majority of actively traded mutual funds fall short of the market average, strategic asset allocation is likely to help you achieve better long-term investment returns.

How To Implement Strategic Asset Allocation

If you want to use strategic asset allocation to build your investment portfolio, here’s a step-by-step guide to help you do it:

1. Identify investment goals: The first step in building any investment portfolio is knowing your specific goal. It could be anything from saving for a house down payment to saving for retirement. Knowing your goal will help guide your asset allocation.
2. Understand your time horizon: Once you’ve identified your specific goal, you can calculate your time horizon. Generally speaking, the longer your time horizon, the more aggressive your portfolio can be.
3. Consider your risk tolerance: It’s important to understand your risk tolerance and risk capacity (meaning the amount of risk you can afford to take) to help you choose your investment allocation.
4. Choose your asset allocation: Once you know your goals, time horizon and risk tolerance, you can build a well-diversified portfolio that fits. The more aggressive a portfolio you want, the more of your money you’ll invest in stocks and less in bonds, and vice versa.
5. Monitor your investments: When you’re using strategic asset allocation, you won’t adjust your portfolio based on changes in the market. However, it can still be helpful to monitor your investments.
6. Rebalance your portfolio: You will likely need to occasionally rebalance your portfolio to get back to your desired asset allocation. This often involves selling off your highest-performing assets to buy lower-performing assets.

Strategic vs. Tactical Asset Allocation

While strategic asset allocation takes a more long-term, buy-and-hold approach to investing, tactical asset allocation does the opposite. It’s a form of active investing where you frequently adjust your portfolio holdings based on short-term fluctuations in the market. 

Tactical asset allocation, often known as active trading or day trading, focuses on quick wins. Your investing decisions have less to do with your specific financial goals and risk tolerance and more to do with changes in the market.

Tactical asset allocation can help you make a profit more quickly. However, it also requires a lot more work. Many active traders make many transactions throughout the day and rely on advanced analysis tools to help them predict market movements. Tactical asset allocation also results in more frequent losses. 

Meanwhile, because strategic asset allocation is a long-term approach, you never benefit from — or are harmed by — short-term market fluctuations.

These two investment strategies are appropriate for entirely different situations. Strategic asset allocation may be better suited to someone investing for a long-term goal, such as retirement or their child’s college education. Meanwhile, tactical asset allocation may be appropriate for someone who wants to earn a regular income from the stock market as a day trader.

Conclusion

Strategic asset allocation may sound complicated, but it’s really just a long-term investment strategy that involves establishing a desired portfolio balance and maintaining it over a long period without giving thought to short-term market fluctuations. It’s the strategy most people use in their retirement accounts when they invest in index funds and target-date funds.

Takeaway

Finding and working with a financial advisor is a great idea. A financial advisor will help keep track of your finances and assist you in attaining your financial goals. While finding the right one can be overwhelming, you can decide to work with a financial advisor in your community or a virtual one.

Get to know your financial advisor options today for free!

Share This Article: