Investors looking to improve their risk-adjusted returns benefit from a tactical asset allocation form of investment. At its heart, tactical, or strategic, asset allocation adjusts the mix of asset classes within a portfolio to match market conditions. It is a proactive strategy, and it works well with short-term market movements to stretch over the long term.
Tactical asset allocation is an investor’s attempt to reduce risk and maximize returns. It involves making informed investment decisions and using trading strategies. This is not about buying certain asset classes in certain quantities and then holding. Instead, balance the percentages of assets held in different categories so you can take advantage of current market conditions.
Here are some ideas for applying tactical asset allocation to your portfolio.
Tactical Asset Allocation Tips
1. Look Beyond the Traditional Approach
A traditional approach to investment portfolios includes attention towards the Efficient Market Hypothesis and the view that the long-term market is relatively stable. In efficient markets, security prices reflect all information and there is no way of beating these markets; randomly choosing stocks is as good as any other option.
Traditional investment involves the buy-and-hold approach. Strategic asset allocation includes diversification to maximize the return per unit. Since markets involve anomalies, and there are issues with believing in the efficient market theory, tactical asset allocation involves active management.
2. Work With Anomalies
One main efficient market anomaly is momentum. Day to day movements in price are random, yet historical momentum tends to be stable over time. Assets chosen on the basis of their historical momentum tend to succeed more when looking at the long game. Also, short-term mean-reversion as an anomaly works well for investors’ maximizing returns.
This concept is when an asset reverts to its mean return rate following a sharp deviation from its mean. This is often explained by market overreaction and investor psychology. It is a good tactic to exploit this anomaly in an unstable market. Combining a set of strategies, for example, mean-reversion and momentum strategies helps promote positive returns across a range of markets. Turning Trader has a page that will explain how this strategy helps boost returns in a tactical asset allocation portfolio.
3. Reduce Your Rainy Day Fund
There will always be recessions. Economies will always suffer downturns. And when this happens, investors risk losing 30% or more of their capital. Strategic asset allocation reduces drawdowns and allows investors to lower the amount they have in their “rainy day” pot. This is also important when you are making a living out of your savings.
4. Know the Risks
Active portfolio management sounds ideal. Yet, it is not without its risks. The strategy requires skill, and it can be time-consuming. It is not for idle or undisciplined investors. The higher number of transactions involved comes with their own fees. And while tactical asset allocation may provide more control by reducing your overall portfolio volatility, with this comes FOMO – the fear of missing out. This approach is based on making more money by losing less. And it works over the long-term. It takes strong discipline to keep charting a course by trailing a set of simpler portfolios over many years.
5. Create Your Ideal Mix
The success of a tactical asset allocation portfolio is due in most part to the effective mix of assets to improve your returns. This is chosen by looking at factors including the investor’s view of risk and acceptable level of risk, tax considerations, time horizon, and required rate of return. Each portfolio is unique.
6. Understand the Fine Print
Tactical asset allocation differs from portfolio rebalancing. In the case of portfolio rebalancing, the trades work to return a portfolio to its base allocation. With tactical asset allocation, the trades adjust the balance in the short term, with the idea of turning back to the original strategic allocation when the opportunities in the short term are not there. Always remember there is a risk in any investment market, but following a well-proven strategy will aid you in minimizing potential losses and maximizing potential gains.
7. Risk tolerance
Usually, the higher the risk, the higher the return. If you take a big risk, you can make big gains or big losses, but if you completely avoid the risk, you probably won’t make any gains or losses. Your ideal portfolio should achieve a careful balance of risk depending on your risk tolerance.
The only security in investing is that it is impossible to consistently predict winners and losers. A prudent approach is to create an investment basket that provides broad exposure within the asset class.
Diversification spreads risk and profit within the asset class. Because it is difficult to know which subgroup of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all sectors over time, while reducing instability.
Actual diversification takes place in various classes of securities, economic sectors, and geographical regions.
Many are by definition low-risk institutional investors like pension funds and livelihoods Insurance companies invest their assets in financial instruments with the aim of achieving more significant yield, but nevertheless when investing should consider all relevant risks arising from these types of investments because their occurrence can significantly affect the final result of the investment as well even lead to negative yields.
Except for the general ones risks such as global political and economic movements, natural and environmental disasters and wars and other crisis situations is additional it is necessary to pay attention to specific risks investments in securities such as:
- Market risk – the risk of changes in value financial assets due to price changes.
- Interest rate risk – risk changes in the “price” of money. Distinctly influential on bond prices, but also on availability capital.
- Liquidity risk – the risk of partial or even complete lack of demand for a financial instrument.
- Currency risk – the risk of changes in value investment currencies relative to other currencies.