A strategic asset allocation is creating a mix of investments over multiple asset classes that takes into consideration your risk tolerance, time horizon and investment objectives. A strategic asset allocation is much more likely to result in a higher return on your assets then just spreading your investment dollars evenly.
An example of a generic asset allocation model that would create a balanced portfolio that might look like this:
Determining which components of a balanced portfolio have what percentage weighting is something that is unique to each investor. The biggest variables in determining the makeup of a balanced portfolio is your age and the amount of risk you are willing to take.
A younger person in their 20s might be a very aggressive investor because they have a number of years to recover if some of their more aggressive investments do not work out as expected. A balanced portfolio for this type of person might be 90% in stocks, 5% in bonds and 5% in cash.
A person in their 60s is likely more conservative because at that age you are more concerned with how to protect your assets and less concerned with large asset appreciation. This type of person might only have a very low percentage invested in stocks, like 20%, with the remaining 80% invested in bonds and cash.
In the end, each balanced portfolio is going to look different based on the unique needs of that investor. The trick is to honestly assess how much risk you are willing to take and build that balanced investment portfolio accordingly.
When in doubt start investing small amounts with conservative investments. Over time you can be more aggressive as your knowledge and comfort level with investing increases.
As a younger person in your 20s you are likely to accept more risk since you hopefully have a long investing life ahead of you. At that age I can see you having a larger percentage of your assets in more aggressive investments like stocks and real estate. At that age your allocation to aggressive assets could be 60% to 70%, or even higher.
As you age you are likely to want to be a more conservative investor as you focus more on capital preservation and less on appreciation.
As many of us will transition from that more aggressive investor to a more conservative investor, what should you look for and how should you adjust your strategic asset allocation in your asset allocation model to account for that change in risk profile?
We need to talk in generalities here because each investors circumstance are different. But the factors I would most closely track are age and progression towards your ultimate financial goal.
As an example, if as a moderately aggressive investor if you are willing to invest 90% in stocks in your 20s and 40% in stocks in your 60s, then I would back off 10% each decade, so that I was not transitioning all at once.
Similarly, if you are in your 20s with $10,000 in investments and have a goal of $400,000 by the age of 65, you could similarly decrease your investments in aggressive stocks by 10% for each $75,000 you accumulate against your goal. Again, this would be transitioning your strategic asset allocation over time, not all at once.
Ah yes, with every rule comes an exception to the rule and in this case the exception to the rule is tactical asset allocation.
Think of strategic asset allocation as the long-term plan and tactical asset allocation as a short term audible.
If there has been a stock market correction of some sort and you believe it will recover in due time, a tactical asset allocation would be to move more of your assets to stocks for a period of time, before you return to your normal asset allocation model.
The use of a tactical asset allocation is meant to boost your returns for short to medium periods of time.
Start investing early to give the laws of compounding the chance to grow your portfolio.
Don’t invest all your assets in one class. Instead build a balanced portfolio that you manage and adjust from time to time.
Start small and increase your investments as you get more comfortable with investing.