Asset allocation is the rigorous implementation of an investment strategy that attempts to balance risk versus reward by adjusting the percentage of eachasset in an investment portfolio according to the investor’s risk tolerance, goals and investment time frame.
1. Strategic Asset Allocation
This method establishes a “base policy mix”, a proportional combination of assets based on expected rates of return for each asset classes. Suppose stocks have historical returns of 10% per year and bonds have returned 5% per year, a mix of 50% stocks and 50% bonds would be expected to return 7.5% per year.
2. Constant- weighting Asset Allocation
Strategic asset allocation generally implies a buy and hold strategy, even if the shift in values of assets caused a drift. For this reason you can choose to adopt a constant-weighting approach to asset allocation. By allocating this approach, you continually rebalance your portfolio. For example, if the value of one asset is decreasing in value, you would want to purchase it and if that asset value increases, you would want to sell it.
There are no hard-and-fast rules to time your portfolio rebalancing under this strategy. However, the common thumb rule is that the portfolio should be rebalanced to its original mix when any given asset class moves more than 5% from its original value.
3. Tactical Asset Allocation
Tactical Asset Allocation can be described as a moderately active strategy, as the overall strategic asset mix is returned to when the short term profits that are desired are achieved.
This strategy also demands some discipline as you need to first be able to identify when short term opportunities run their courses, and then rebalance your portfolio.
4. Dynamic Asset Allocation
In Dynamic Asset Allocation, you constantly adjust the mix of assets as markets rise and fall, and as when the economy strengthens and weakens. In this strategy, you sell assets that are declining and purchase assets that are increasing in markets. This asset allocation is in polar opposite of a constant-weighting strategy.
5. Insured Asset Allocation
You establish a base portfolio value under which the portfolio should not be allowed to drop in Insured Asset Allocation. This may be suitable for risk-averse investors who desire a certain level of active management of portfolio. For example, an investor who wants to establish a minimum standard of living during retirement may find insured asset allocation strategy being ideally suitable to reach their management goal.
6. Integrated Asset Allocation
Here, an investor considers both his economic expectations and risk in establishing an asset mix. It is a broader asset allocation strategy, though allowing only either dynamic or constant-weighting allocation.
All the strategies mentioned above are dependent upon the investor preferences and their risk taking appetite. Choose your asset allocation strategy appropriately in your portfolio.