What Is Tactical Asset Allocation?

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Asset allocation refers to how you divide up your money among different assets, such as stocks, bonds and cash. Most investors follow a long-term approach called strategic asset allocation, which considers factors like risk tolerance, time horizon and financial objectives. More active investors, however, may opt for tactical asset allocation, which involves frequent adjustments.

Here’s a look at the ins and outs of tactical asset allocation and how you can determine if it’s a good choice for you. 

How Tactical Asset Allocation Works

At its core, tactical asset allocation works just like strategic asset allocation, with investors deciding how much of their portfolio to assign to different assets. However, unlike the long-term approach of strategic asset allocation, tactical asset allocation is more active. It responds to current market trends or economic shifts, adjusting as conditions change or as investors anticipate change.

Here’s a quick summary of the two:

• Strategic asset allocation focuses on long-term growth, aiming to benefit from the expected returns of various asset types.
• Tactical asset allocation looks to profit from short-term market changes. It takes advantage of assets that are temporarily undervalued compared to their long-term averages.

Tactical Asset Allocation vs. Strategic Asset Allocation: Example

Imagine that two investors have the same asset allocation of 60% stocks, 30% bonds and 10% cash.

If inflation and interest rates rise dramatically, a strategic asset allocator might make no changes at all to their portfolio.

But a tactical asset allocator might boost their bond and cash allocations to take advantage of higher interest rates and to protect themselves from a potential recession and stock market selloff. 

Benefits of Tactical Asset Allocation

While tactical asset allocation isn’t for everyone, it does carry some clear benefits. Here are the most important:

• Potential to boost returns: Tactical asset allocation aims to capture higher returns by shifting investments into assets with stronger short-term potential. For example, if the stock market drops but the economy shows improvement, investors might increase their stock holdings to benefit from a market rebound.
• It can exploit short-term market inefficiencies: Unlike strategic asset allocation, which is long-term, tactical asset allocation moves money from overpriced assets to undervalued ones, aiming to profit as these short-term price differences correct.
• Provides flexibility: Strategic asset allocations are fairly rigid, typically only changing as investors age or if they go through a dramatic life change. But tactical asset allocations remain flexible, allowing investors to quickly adapt to current market conditions.

Risks and What To Consider

Tactical asset allocation certainly has its share of benefits. But it also carries various risks. Here are the ones that you should be aware of:

• Timing the market is inherently risky: Tactical asset allocation involves trying to time the market, which is notoriously challenging. Even one poorly timed move can erase gains from a successful decision, making it a risky approach.
• It can carry significant tax consequences: Tactical asset allocation requires frequent trading in and out of different asset classes, so there may be serious tax ramifications for investors who use it. If you’re making money buying and selling stocks, bonds and other assets multiple times per year, you’ll be responsible for short-term taxation on all of the trades you make with a holding period of one year or less. These taxes can reduce profits, perhaps to the point that they nullify any advantages over strategic asset allocation.

Who Should Consider Tactical Asset Allocation

Tactical asset allocation offers some benefits, but it’s not for everyone. Buy-and-hold investors, for example, would be better suited to strategic asset allocation. But those looking to exploit short-term market movements might prefer tactical asset allocation instead. 

Of course, to succeed with tactical asset allocation, investors need to have the knowledge to make timely moves. This requires constant attention to markets and macroeconomic indicators, something that can be too time-consuming or labor-intensive for many investors. But for those who are avid followers of financial markets, tactical asset allocation could make sense. 

Investors with a high-risk tolerance are also better suited to tactical asset allocation, as the inherently risky nature of moving in and out of various asset classes can be too much for more conservative investors to handle. 

Conclusion

Tactical asset allocation is an aggressive, quick-moving strategy that aims to take advantage of imbalances in market asset classes. It takes a shrewd eye and a tolerance for risk, but it offers the potential for higher-than-average returns if it’s pulled off successfully. Just remember the potential tax consequences of short-term capital gains and the damage that market timing — which is hard even for professionals — can do to your portfolio.

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!

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