Are you trying to come up with the perfect blend of investments for your portfolio? With so many strategies available, individuals new to investing can be confused by all of the different options marketed to them.
If you’re new to investing, active asset allocation strategies might feel overwhelming to study and implement without the help of a skilled financial professional. That said, it doesn’t have to be overly complex, and understanding the basics can help guide your decision-making. Here’s what you need to know and some of the most common strategies for success.
What is Active Asset Allocation?
Before diving into the difference between active and passive asset allocation, let’s start with what asset allocation actually means and how it helps balance risk.
In this strategy, you will divide your portfolio into various asset classes such as equity, fixed income, real estate, precious metals, cash, and more. The overall goal is to expose yourself to as little risk as possible because each of these asset classes is not directly related to the others.
Asset allocation is divided into two categories: active and passive. Active asset allocation has the primary goal of trying to beat the market at every turn. You may be actively buying or selling the various assets in your portfolio in time with market trends. It is a very hands-on way to approach investments.
On the other hand, passive asset allocation simply aims to mimic a benchmark. You likely are not as engaged in buying and selling because your portfolio is compared to a well-known benchmark such as the S&P 500. The allocation of assets in a passive portfolio does not usually correspond with changing market trends.
Active Asset Allocation Strategies
As with any investment, there’s no surefire technique that can guarantee success, but a tactical approach can reduce your risks and put you in position to come out ahead. Here are eight strategies that you may consider implementing with your own portfolio.
Age-Based Asset Allocation
The first strategy that many people employ in active asset allocation is age-based. This strategy assumes that you will want more risk (and therefore the potential for greater gains) during your younger years and move to more reserved investing as you age.
To calculate your age-based asset allocation, subtract your age from 100 and this tells financial experts what percentage should be in equity funds. The remainder of your percentage should be invested in other asset classes. For example, someone who is in their forties will want about 60 percent of their portfolio in equity funds.
Life-Cycle Funds Asset Allocation
Another strategy is life-cycle funds asset allocation, also referred to as target date asset allocation. This strategy can be a bit tricky to employ on your own, so it is worth discussing it with a financial expert. It takes your age, financial goals, and willingness to assume risk into consideration before coming up with a portfolio that can yield dividends for your return on investment. One should be careful to consider expenses, however, since these “funds of funds” can have a couple of layers of fees.
Strategic Asset Allocation
Strategic asset allocation may be one of the most well-known forms of active asset allocation. In this model, you will invest in a group of assets that is balanced for your risk tolerance and the timeframe in which you want to see those returns. As time passes, you can readjust to make sure you are sticking close to your targets. You may also adjust your allocation to take advantage of the market super cycle, or boom/bust cycle.
Oftentimes, this means that you will buy and hold various assets instead of trading frequently, but you may shift your overall exposure from equities to fixed income and vice versa as market conditions change. It also means that you will keep a great deal of diversification in your portfolio to minimize overall exposure to risk.
Tactical Asset Allocation
In many ways, tactical asset allocation is the inverse of strategic asset allocation. Investors using this method will more heavily consider short-term investments instead of holding for the long term. In other words, you want to use “tactical” decisions to make the most of what is hot on the market in the here and now.
Because you are buying and selling assets with more regularity, you can quickly adapt to any changes in the market. Of course, this also means that you may need to rebalance your portfolio more frequently as short-term investments are removed from the portfolio.
Constant-Weight Asset Allocation
Similar to the strategic method, constant-weight asset allocation adheres to a buy-and-hold policy. If you notice that a stock loses some of its value, the first thing you should do is scoop up some extra shares. On the other hand, you may want to sell shares if their value dramatically increases and can net you a tidy profit.
Dynamic Asset Allocation
Dynamic asset allocation is the direct opposite of constant-weight asset allocation. While you still make regular adjustments to your overall portfolio in accordance with market trends, you do so in the opposite way. Instead of buying more assets as they decline in value, you will sell shares that are no longer performing.
You will also purchase assets as they appear to be on the upswing instead of when they are on the low side.
Insured Asset Allocation
If you worry about taking on too much risk with your portfolio, insured asset allocation could be the right fit for you. This method allows you to set a base asset value that your portfolio should never drop below. When it does dip below this agreed-upon number, you will buy or sell in order to minimize your overall risk.
On a regular basis, you can choose to buy, sell, or hold depending on how you can get the most value in comparison to your base asset.
Integrated Asset Allocation
Integrated asset allocation is similar to insured asset allocation because it allows you to set up your expectations and your tolerance for risk accordingly. It takes into consideration the investor’s expectations of revenue generation, current changes in the market, and risk tolerance.
It can often be used in conjunction with other strategies such as dynamic asset allocation, but you should be clear not to use two methods that contradict each other (such as strategic asset allocation and tactical asset allocation).
Get the Strategic Advice You Need
Understanding the ins and outs of active asset allocation can be involved, so trust your finances to the professionals at Magellan Planning Group. We offer comprehensive estate, financial, and tax planning to help with everything from fee-only investment accounts to tax-advantaged charitable giving. Reach out to us today to learn more about how we can help you with your asset allocation!
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.
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