- Strategic asset allocation enables an investor to set allotments for various investment classes.
- Target allocations depend on time horizon, risk tolerance, and investment objectives.
- Rebalancing your portfolio is necessary when the original allocations deviate from the original settings.
Ultra-high net worth individuals may need a consolidated and global view of their wealth structure with return indicators and a qualitative diagnosis. Many tools could be used to this effect, but none is more operative than strategic asset allocation (SAA).
An SAA is an investment approach that enables you to align the makeup of your portfolio based on your risk tolerance. In other words, the model helps you understand your investment profile and defines an optimal asset allocation depending on your goals and risk constraints. The goal is to help you optimize the risk-return profile of your investment.
A well-planned SAA model can make deciding how much of your money you should invest in broad investment categories like stocks and bonds much simpler. It also helps you plan for smaller sub-categories such as U.S. small-cap and mid-cap stocks.
One key difference between SAA and other portfolio drivers is that it’s set in advance. The investment team determines factors like tactical decisions, factor exposures, and fund selection throughout your investment time horizon.
Factors Affecting Strategic Asset Allocation
Your investment portfolio distribution depends on three crucial factors when you’re making important investment decisions:
Your return objectives or goal factors are the financial targets you want to reach with your SAA. You may require a more aggressive investment allocation if your goal is to achieve capital growth. A fixed income returns objective calls for a more conservative approach in your asset allocation strategy.
Consider how long you intend to hold on to your investments. You can afford to be more aggressive in your investment approach if you don’t need the money for a long time. If you project a longer time horizon for your investment, you generally shouldn’t be upset by the volatility that comes with an aggressive allocation. That means the longer you stay invested, the greater risk you’re taking. Short time horizons allow you to take little risk or no risk at all.
Your Risk Tolerance
Having too much risk in your portfolio may seem like a massive mistake. Taking on too little risk, or no risk at all, though, can reduce or adversely affect your ability to achieve your financial goals – especially when considering the effects of inflation. Check that your portfolio has an appropriate level of diversification across and within each asset class to help you remain invested for the longer term.
It is imperative to consider your objectives, your willingness to take risks, and your timeline when considering strategic asset allocation. The following section will help you understand more about how it works.
How Strategic Asset Allocation Works
One outstanding feature of SAA is that once you decide upon an allocation, you stick with it for many years. The main selling point of this investment strategy is to help you work steadily toward a financial goal over a long period. Doing so prevents you from making short-term decisions based on current market events.
The approach borrows its foundation from the modern portfolio theory, which holds that markets are efficient and follow specific patterns that are more reliable than human investors. Instead of speculating on financial trends, the approach enables you to take advantage of the built-in efficiency of the market through a fixed set of assets and a balanced portfolio.
Strategic asset allocation is ideal for aggressive investors with greater risk tolerance. It allows them to put their money in more stock if they aim to maximize long-term growth. An SAA recommendation, for example, might suggest investing 70% in stocks, 20% in bonds, and 10% in cash. A more modest approach would recommend 60% stocks and 40% bonds.
Maintaining Your Asset Allocation
Settling on a strategic asset allocation investment strategy means you must then maintain it. This also means you must regularly check the portfolio to ensure it is well-aligned. You may need to rebalance it on a pre-set schedule so that, in the event it becomes misaligned, you can restore it to the original allocation.
Consider this strategic asset allocation example: Assume you started with an investment portfolio of 60% stocks and 40% bonds. After a year, you find the portfolio is 70% stocks and 30% bonds. Under the SAA strategy, you would have to sell the excess 10% in stocks to bring the target back to 60%, even if the stocks are currently performing well.
The aim is to reinvest the proceeds into bonds to balance the portfolio. The overall goal of SAA is to enable you to stay with your original plan, ideally preventing you from occasionally shifting your goal posts based on market dynamics.
If you obtain information that may call for changes in the allocation, though, it’s OK to make and stick with those changes. This information should be something that alters your willingness and comfort in taking more or less risk and should not simply be a shift based on the assets’ performance or on the market itself.
Determining Whether You Need Strategic Asset Allocation
SAA is an ideal investment strategy for the typical buy-and-hold investor, rather than tactical asset allocation, which is more suited to active trading. SAA is a perfect strategy for saving for long-term goals like retirement planning.
To get a strategic asset allocation, determine how much you want your allotment to be and break down each asset class. For example, you can break down stocks into large or small caps, U.S. international, or emerging markets. You then need to develop a plan and purchase the funds.
Engaging the services of asset allocation professionals can ease the burden, making it easier to arrive at the most suitable decision for your portfolio. Contact Bogart Wealth to speak with an expert about strategic asset allocation and any other investment concerns you may have.