Asset allocation approaches are frameworks that guide investors on how to distribute their investments across various asset classes, such as equities, fixed income and cash, to achieve a specific objective. These models range from conservative to aggressive, each catering to different levels of risk tolerance, investment horizons, and financial goals. Let's dive into some of the most commonly utilised asset allocation models.
STRATEGIC ASSET ALLOCATION
Strategic asset allocation is a long-term approach that sets fixed percentages for each asset class within a portfolio, based on an investor's risk tolerance, goals and investment horizon. This model maintains a balanced and diversified portfolio over time, only requiring periodic rebalancing to keep asset classes within their target allocations. It's akin to setting a course for a long journey, making only slight adjustments to stay on track.
TACTICAL ASSET ALLOCATION
Tactical asset allocation is more flexible and opportunistic. It allows investors to temporarily deviate from their strategic asset allocation to take advantage of short-term market opportunities or to hedge against imminent market downturns. This approach requires active management and a deep understanding of market trends, as it involves making informed bets on asset class performance.
DYNAMIC ASSET ALLOCATION
Dynamic asset allocation is an active management strategy that involves frequently adjusting the mix of asset classes in a portfolio in response to changing market conditions and economic indicators. This approach seeks to capitalise on market trends by increasing exposure to asset classes expected to perform well and decreasing exposure to those expected to underperform. It requires continuous monitoring and adjustment, making it suitable for experienced investors with a higher risk tolerance.
CORE-SATELLITE ASSET ALLOCATION
The core-satellite asset allocation combines elements of both passive and active management. The ‘core’ of the portfolio consists of passive investments in broad market indices, providing stability and exposure to the overall market. The ‘satellite’ components are actively managed investments, selected to pursue higher returns or to hedge against specific risks. This model aims to offer the best of both worlds: the low costs and broad market exposure of passive investing, with the potential for higher returns from active management.
CONSTANT-WEIGHTING ASSET ALLOCATION
Constant-weighting asset allocation involves regularly rebalancing the portfolio to maintain original asset allocation percentages. It forces the investor to buy low and sell high by reallocating investments from over-performing asset classes to under-performing ones to match the original asset allocation. This disciplined approach helps maintain a consistent risk level over time and can lead to potentially better long-term returns.
LIABILITY-DRIVEN ASSET ALLOCATION
A liability-driven asset allocation approach is primarily used by pension funds and insurance companies. It focuses on matching investment assets to future liabilities, ensuring that there are sufficient funds to cover upcoming expenses or payouts. This model is highly customised and involves investing in assets with cash flows that align with the timing and magnitude of expected liabilities.
AGE-BASED ASSET ALLOCATION
Age-based asset allocation, commonly seen in retirement planning, adjusts the asset mix as the investor ages. Typically, it suggests a higher allocation to stocks for younger investors and gradually shifts towards bonds and safer assets as the investor nears retirement. This model is based on the principle that younger investors can afford to take on more risk for higher potential returns due to their longer investment horizons.
Choosing the right asset allocation model is crucial for achieving financial goals while managing risk. Investors should consider their risk tolerance, investment objectives and time horizon when selecting a model. It's also beneficial to consult with a financial adviser to tailor an asset allocation strategy that best fits individual needs and preferences.
This Trustnet Learn article was written with assistance from artificial intelligence (AI). For more information, please visit our AI Statement.