Strategic Asset Allocation

What Is Strategic Asset Allocation?

Strategic asset allocation is a portfolio strategy. The investor sets target allocations for different asset classes and rebalances the portfolio occasionally. The portfolio is rebalanced to the original allocations when they go amiss fundamentally from the initial settings due to contrasting returns from the different assets.

Grasping Strategic Asset Allocation

In strategic asset allocation, the target allocations rely upon several factors: the investor's risk tolerance, time horizon, and investment objectives. Additionally, the allocations might change over the long run as the boundaries change. Strategic asset allocation is viable with a buy-and-hold strategy rather than tactical asset allocation, which is more fit to an active trading approach. Strategic and tactical asset allocation styles depend on modern portfolio theory, which stresses diversification to reduce risk and further develop portfolio returns.

Strategic Asset Allocation Example

Assume 60-year-old Mrs. Smith, who has a conservative approach to investing and is five years from retirement, has a strategic asset allocation of 40% equities/40% fixed income/20% cash. Expect Mrs. Smith has a $500,000 portfolio and rebalances her portfolio yearly. The dollar amounts allocated to the different asset classes at the hour of setting the target allocations would be equities $200,000, fixed income $200,000, and cash $100,000.

In one year's time, assume the equity part of the portfolio has produced total returns of 10% while fixed income has returned 5% and cash 2%. The portfolio structure is presently equities $220,000, fixed income $210,000, and cash $102,000.

The portfolio value is currently $532,000, and that means the overall return on the portfolio over the course of the last year was 6.4%. The portfolio organization is currently equities 41.3%, fixed income 39.5%, and cash 19.2%.

In view of the original allocations, the portfolio value of $532,000 ought to be allocated as follows: equities $212,800, fixed income $212,800, and cash $106,400. The table below shows the changes that must be made to each asset class to return to the original or target allocations.

Asset Class	Target Allocation	Target Amount (A)	Current Amount (B)	Adjustment (A) - (B)
Equities	40%	$212,800	$220,000	($7,200)
Fixed Income	40%	$212,800	$210,000	$2,800
Cash	20%	$106,400	$102,000	$4,400
Total	100%	$532,000	$532,000	$0

In this manner, $7,200 from the equity part must be sold to take the equity allocation back to 40%, with the proceeds used to buy $2,800 of fixed income, and the balance of $4,400 allocated to cash.

Note that while changes to target allocations can be carried out whenever, they are done moderately inconsistently. In this case, Mrs. Smith might change her allocation in five years, when she is on the verge of retirement, to 20% equities, 60% fixed income, and 20% cash to reduce her portfolio risk. Contingent upon the portfolio value around then, this would require massive changes in the organization of the portfolio to accomplish the new target allocations.

Features

The portfolio is rebalanced when the original allocations veer off essentially from the initial settings due to varying returns.
Strategic asset allocation is a portfolio strategy by which the investor sets target allocations for different asset classes and rebalances the portfolio occasionally.
The target allocations depend on factors like the investor's risk tolerance, time horizon, and investment objectives.