Asset allocation is where the rubber meets the road with your investing; it will determine how much risk you are exposed to, and will also be a significant determinant of your returns (positive or negative). 

This article will take a deep dive into what asset allocation is, why it is important, and what you should consider when you are managing your own asset allocation, or having an advisor/robo-advisor do it for you. What is Asset Allocation?

Simply put, asset allocation can be explained by how you position your portfolio among the different asset classes. The most common way way of visualizing asset allocation is via a pie graph showing the respective percentages of your portfolio that are dedicated to equities, fixed income, cash and alternatives (if applicable). Your asset allocation can range from ultra-aggressive (primarily equities) to ultra-conservative (primarily bonds and cash). Generally speaking, it wise wise to dedicate most of your time and energy to putting together an asset allocation that is suitable for you as an investor.

What are the Benefits of Asset Allocation?

The main premise behind asset allocation is the idea of spreading out your risk among different asset classes. So, in theory, if a part of the market, or a specific asset class is underperforming, your entire portfolio won’t feel as large of a hit. Asset allocation tends to go hand in hand with the idea of diversification (which also aims to reduce portfolio volatility). While there may be a valid argument that spreading out your risk may limit returns, asset allocation becomes increasingly more important as your investable net worth increases. Like the old saying goes: “It’s not about how much you make, but how much you keep.” It’s not just about the downside protection, however. Keep in mind that you will still have exposure to different asset classes and parts of the market. If those areas outperform, you will participate in that growth as well. While it won’t make your portfolio bulletproof from volatility, proper asset allocation provides investors with the ability to protect their principal from concentration risk (too much of one investment) and also allows them to participate in broader market growth, which is just as critical for long-term success.

What Is Strategic Asset Allocation?

“Strategic” Asset Allocation is the process of selecting a particular mix of asset classes with the idea of holding onto that allocation for a long time (10+ years). An investor that sticks to a strategic asset allocation strategy is likely a passive investor that primarily uses indexing and other passive vehicles to capture broader overall market growth over time. Strategic asset allocation tends to go hand-in-hand with Modern Portfolio Theory (MPT), which states that markets are generally efficient and that keeping a diversified approach without attempting to ‘time’ the market is a wise play.

What Is Tactical Asset Allocation?

By most standards, tactical asset allocation is the opposite of strategic asset allocation. This strategy is much more active in nature. Investors that follow this philosophy believe that the market tends to present opportunities through mispricing of securities, and other events that may lead to arbitrage. Instead of having a long-term target allocation, managers that use tactical asset allocation have a much shorter time frame that they use to analyze the positioning of the assets within their portfolios. Investors that use this approach may not believe as much in the theory of market efficiency and Modern Portfolio Theory.

What Is Core-Satellite Asset Allocation?

Core-satellite in a sense can be considered a mix between tactical and strategic asset allocation. In most cases, the “core” portion of the allocation is dedicated to broad-based, diversified exposure to different asset classes. This is typically done through indexing or using ETFs. The “satellite” portion is usually a more active component of the overall allocation. This is where active strategies, hedging and exposure to alternatives may play a role. Many financial advisors and portfolio managers implement this strategy when their clients or investors demand a little more than just a “plain-vanilla ETF portfolio”.

What Is Portfolio Rebalancing?

Rebalancing is a core component of nearly any investment strategy, primarily strategic asset allocation. Rebalancing is the act of making the trades necessary to bring your portfolio back into alignment with your intended investment mix. With time, your investment allocation can “drift” with the market. Think of it like a boat drifting off at sea. This can happen if the stock market runs up, or even down. The same goes for the bond market. Rebalancing can potentially allow you to lock in gains in an asset class that is outperforming; and use those gains to purchase assets of a different class that may be at a discount. A classic example of this is selling off bonds when they are rallying to buy stocks when they are trading at depressed prices. Rebalancing may not always provide you with immediate returns. In fact, it may seem unattractive when a particular asset class is providing you with healthy returns. However, almost all investment professionals agree that it is a crucial element of a long-term investment plan.

What Asset Allocation Is Right For Me?

This is a great opportunity to remind you that every single investor is unique. Why? Because every single investor has different circumstances, goals, preferences and needs. There is no “one size fits all” asset allocation (although Ray Dalio’s ‘All Weather Portfolio’ is an interesting case study). Whether you’re constructing your own allocation or you’re getting help from an advisor, here are some things you want to keep in mind: RISK TOLERANCE: Risk is one of the most important areas of investing that you can study. Every single investor has their own level of risk tolerance. There is no “right” or “wrong” answer here. Only you can truly know your level of comfort with risk. When deciding on an allocation, this may be a great place to start. GOALS: Goals should always be driving the conversation in your finances. That principle carries over to your investing as well. One of the primary functions of a financial advisor is to create a plan that puts their client in the best position to be successful in meeting their financial goals. The advisor may do this through modeling and analyses (like a Monte Carlo). In either case, the “best” asset allocation is the one that puts the client in a position to meet their goals while taking on the least amount of risk possible. TIME HORIZON: Time is another crucial element in the investing equation. As a general rule, the more time you have until you’ll be relying on your invested dollars, the more risk you can afford to take. This is why it makes sense to have an aggressive allocation when you’re young. As you get older, or closer to your goal, it makes sense to begin paring back the risk you expose yourself to. INDIVIDUAL PREFERENCES: In today’s world, thematic investing is much more prevalent than ever. As such, there are more and more options available to investors that are passionate about certain themes (like sustainability, religion, etc). If you are working with an advisor, you can have a conversation with him or her to see what options are on the table for your mix that are in line with your ethical stance. If you’re creating your own investment allocation, the burden of the due diligence is on you.

Robo-Advisor or Human Advisor?

If you’re not comfortable with creating your own asset allocation, that is okay. There are plenty of options on the table. The advent of technology has brought robo-advisors the forefront of the investment management conversation. As such, investors now have to ask themselves: “Do I want to work with a human, or am I comfortable with a ‘robo-advisor’?” Again, there is no right or wrong answer here. However, there are some important points to note. The benefit of working with a human financial advisor is just that; you’re working with a human. You’ll be partnering up with someone that you can have personal conversations with regarding your finances and investing. Many people like the idea of having a single point of contact that they can go to with their investing and planning needs. Because you’re getting a more individualized level of service, your costs may be higher than a robo-advisor. If you aren’t picky about having a single point of contact, or a human quarterbacking your investments, then a robo-advisor may make sense. As mentioned, this alternative is usually cheaper than working with a full service, traditional financial advisor. If you go the advisor route, it’s wise that you are comfortable and familiar with the platform. You should do your due diligence and understand the process and philosophy behind the investment selection, rebalancing, fees and anything else that is important to you. Conclusion Asset allocation is arguably the most important element of an investor’s investment planning. It dictates how much risk you are exposed to, and is the primary determinant of your returns. As an educated investor, you should strive to always make sure your asset allocation is suitable and in line with your investment objectives, as well as personal circumstances and preferences. While there are many schools of thought when it comes to the subject, there is still no “one size fits all” solution when it comes to how you position your assets. Technology has made it possible for anyone to become an investor today. Leverage the tools and knowledge that are at your disposal. Balance and discipline in your investing go a long way. If you’re not comfortable with creating and tending to your own mix, there are plenty of options available in the marketplace depending on your style and needs. Keep striving to invest responsibly and intelligently. Prudent asset allocation is half the battle.


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