Strategies

Asset allocation strategies provide the blueprint for how a portfolio is structured. Before choosing individual securities, an adviser must decide on the overall mix of asset classes and how rigidly to stick to that mix over time.

Strategic Asset Allocation

Strategic asset allocation is the long-term approach to portfolio construction. It sets target percentage weights for each asset class based on three client-specific factors:

• Goals: What the client needs the portfolio to accomplish (retirement, education, wealth preservation)
• Risk tolerance: How much volatility the client can accept
• Time horizon: How long before the client needs the money

A typical strategic allocation might look like: 60% stocks, 30% bonds, 10% cash.

The key principle: once targets are set, you stick with them through market ups and downs. The portfolio only changes when the client's circumstances change, not because of short-term market movements.

Rebalancing

Over time, market movements cause the actual portfolio to drift from its targets. If stocks outperform bonds, a 60/40 portfolio might become 70/30. Rebalancing is the process of selling winners and buying underperformers to bring the portfolio back to its target weights.

There are two main rebalancing approaches:

Both methods enforce a natural "buy low, sell high" discipline: you are always trimming what has gone up and adding to what has gone down.

Think of it this way: Rebalancing is like pruning a garden. When one plant grows too tall and crowds the others, you trim it back and give the smaller plants more room. The portfolio stays balanced, and you are systematically selling high and buying low.

Buy and Hold

Buy and hold is the simplest form of strategic allocation. The investor purchases securities and holds them for the long term regardless of short-term market fluctuations.

• Minimizes transaction costs and capital gains taxes
• Relies on the belief that markets rise over the long term
• Works best for investors with long time horizons and high risk tolerance
• Does not involve active rebalancing (unlike strategic allocation with rebalancing targets)

Exam Tip: Gotchas

• Buy and hold does NOT guarantee profits. It is a passive strategy that minimizes costs, but the portfolio can still lose value if markets decline.

Tactical Asset Allocation

Tactical asset allocation takes a different approach. Instead of maintaining fixed targets, the adviser makes short-term deviations from the strategic allocation to capitalize on perceived market opportunities.

• Involves market timing and sector rotation (shifting money toward sectors expected to outperform)
• More active and potentially higher cost than strategic allocation
• Generates more taxable events due to frequent trading
• Requires correct market forecasting to add value, and research shows this is very difficult to do consistently

Exam Tip: Gotchas

• Rebalancing is NOT the same as tactical allocation. Rebalancing brings the portfolio back to its original targets after market drift. Tactical allocation deliberately moves away from targets to exploit short-term opportunities, then returns to the strategic allocation once the opportunity passes.

Strategic vs. Tactical: Side by Side