If the intricacies of portfolio allocation are enough to make your head spin, or the techniques just too baffling, you don't have to rely on default textbook principles. Bypass the complex mathematical models and look at portfolio allocation from a more thematic perspective. Gone are the days of 60/40 allocation models that served previous generations of investors. Make room for new ways of envisioning the distribution of your assets.
Strategic Asset Allocation
Strategic asset allocation is the kind of asset allocation that most people are familiar with: You grab a few asset classes -- be they stocks, bonds, cash or some mixture thereof -- and apportion a certain percentage of them to your portfolio according to your particular risk profile and return goals. This approach essentially lays down a long-term investment policy, which you then follow without regard to any current market activity. Periodically, you review the performance of the portfolio and make "rebalancing" adjustments to bring the portfolio back in line with your initial performance targets.
Tactical Asset Allocation
Also known as "timing the market," tactical asset allocation seeks to exploit the pricing anomalies arising from short-term market conditions and to profit from those inefficiencies as they occur. Tactical allocation is based on the belief that markets will return to their historic mean. Portfolio managers change the allocation of asset classes in anticipation of that reversion. However, in doing this, you could be missing out on trends that could have made you money if you had not chosen to make these reactive adjustments.
Multi-Strategy and Overlays
Portfolio managers sometimes combine allocation strategies as a way of adding greater flexibility to a portfolio. For example, using a strategic portfolio allocation as the foundation of the portfolio, a manager might apply tactical elements to the long-term framework. He might do this in several ways: by including tactical adjustments as an overlay to the strategic framework, allowing you to shift in and out of different asset classes depending on market conditions, or alternately by reserving a certain percentage of the portfolio for the strategic approach and a smaller percentage for the "satellite" portion of the portfolio that is tactical.
Evolution of Allocation Techniques
"Enterprising Investor" observes that portfolio allocation techniques are undergoing a transformation. The focus is turning away from distinct asset classes, as in "traditional" approaches to allocation, in favor of criteria based on market risk factors and manager skill. In this particular approach to portfolio allocation, the product, its "style" and geographic character do not matter as much as the different market risk exposures provided by the investments. Investments will be viewed in terms of their absolute returns and be included in a portfolio based on the return-generating edge a particular manager demonstrates -- not necessarily on the structure or form of the investment.
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