Quick Answer
Asset allocation drives returns more than security selection. Strategic allocation is the long-term client-driven target; tactical allocation is short-term market timing that returns to target. Active management tries to beat a benchmark at higher cost; passive matches it cheaply. Diversification cuts unsystematic risk only, and dollar-cost averaging buys more shares when prices fall.
The whole unit on one sheet: the allocation approaches, management styles, and the techniques the exam loves to test.
The One-Liners That Win Points
- Asset allocation is the single most important decision; how you split across classes matters more than which securities you pick.
- Strategic asset allocation is the long-term "policy portfolio" target, changed only when the client's fundamental circumstances change.
- Tactical asset allocation is a short-term deviation to exploit a market view (asset-class market timing), then returns to strategic targets.
- Rebalancing restores strategic targets by selling overweight winners and buying underweight losers, enforcing a buy-low, sell-high discipline.
- Active management aims to beat a benchmark; most active funds underperform after fees over long periods.
- Passive management aims to match a benchmark, rests on the Efficient Market Hypothesis (EMH), and runs cheaper with lower turnover and higher tax efficiency.
- Growth investing targets above-average earnings growth (higher price-to-earnings ratio, low dividends); value investing targets undervalued stocks (lower price-to-earnings ratio, higher yield), betting on mean reversion.
- Diversification reduces unsystematic (diversifiable) risk but never eliminates systematic (market) risk.
- Dollar-cost averaging (DCA) invests a fixed dollar amount at regular intervals, buying more shares when prices are low and fewer when high.
- Protective put limits downside; covered call generates premium income but caps upside.
Numbers to Lock In
| Item | Value |
|---|---|
| Correlation for maximum diversification benefit | negative 1.0 (opposite directions) |
| Correlation with no diversification benefit | positive 1.0 (perfect lockstep) |
| Threshold-based rebalancing band (example) | plus or minus 5% from target |
| Regulation T initial margin | 50% of purchase price |
| FINRA minimum maintenance margin | 25% equity |
| Beta above 1 | more volatile than the market |
Top Gotchas
- Strategic vs. tactical: allocation changing because the client's goals, risk tolerance, or timeline changed is strategic; a temporary overweight to chase a short-term opportunity is tactical.
- Active vs. passive: active bets markets are inefficient and charges more; passive bets markets are efficient (EMH) and wins on low cost and tax efficiency. Even a small fee gap compounds heavily over time.
- Value vs. growth timing: value stocks outperform in recoveries and downturns; growth stocks outperform in bull markets and expansions.
- DCA uses a fixed dollar amount, NOT a fixed number of shares; buying 100 shares monthly is not DCA. Average cost per share is always lower than average price per share in a fluctuating market, but that is a math relationship, not a guaranteed profit.
- Diversification leaves ALL systematic risk in place; the risk remaining after full diversification is market risk.
- Leverage and inverse or leveraged ETFs cut both ways: leverage amplifies gains and losses, and daily-reset inverse funds decay over time, making them unsuitable for buy-and-hold.
One-Breath Recap
Asset allocation beats security selection. Strategic allocation is the long-term, client-driven target you rebalance back to; tactical allocation is a short-term, market-driven deviation that returns to target. Active management tries to beat a benchmark at higher fees and turnover while most funds underperform after costs, and passive management just matches the index cheaply on the Efficient Market Hypothesis. Growth chases earnings and wins in expansions, value hunts bargains and wins in recoveries. Diversification kills unsystematic risk but never market risk, dollar-cost averaging buys more shares when prices fall, and protective puts guard downside while covered calls sell away upside for income.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Portfolio Management Strategies unit for the complete lesson.