The short version
- Tactical asset allocation is an investment strategy that aims to optimize risk and return by dynamically adjusting portfolios.
- Tactical asset allocation portfolios consider asset class, sector, geography, and other key details.
- Both individual and institutional investors use tactical asset allocation to build short- to medium-term investment horizon portfolios.
How does tactical asset allocation work?
Tactical asset allocation is a portfolio management strategy that takes a semi-active approach to investment management. Under a TAA plan, investors focus on the short-to-medium term when choosing asset allocation. With a typical three-month to one-year horizon, you can make portfolio adjustments around expected economic and market conditions while maintaining a primarily passive portfolio.
The underlying premise of TAA is that markets are not always efficient, and there are times when certain asset classes or sectors may be under- or over-valued. By actively managing a portfolio and making strategic adjustments, a TAA manager may be able to add value beyond what is possible through passive investing strategies.
TAA strategies can take many forms, but all share a common goal: outperforming a benchmark index or investment strategy. At a high level, TAA may involve creating a simple breakdown of assets between stocks, fixed income, cash, and alternative investments. You can further break down your target allocation within each category by factors such as company size, industry, country or region, pricing anomalies, and more.
Tactical asset allocation isn’t an all-or-nothing strategy. It allows you to choose between ETFs and mutual funds or a portfolio of single stocks and other direct investments. Or you can pick a mix of the two. TAA doesn’t have to include stock picking, though it can if you want to make those investment choices.
In action, TAA helps investors and investment managers minimize risk and, hopefully, maximize returns. It’s a far more active strategy than investing in low-fee index funds for the long term. But it’s still more passive than an active stock-picking plan. TAA offers a balance of both to keep investors on track for their financial goals.
Read more >>> Why I Mostly Skip Active Stock Trading
Tactical asset allocation vs. strategic asset allocation
You might have come across the term strategic asset allocation — the definition is very similar to tactical asset allocation.
In general, a strategic asset allocation is a longer-term approach that focuses on creating a diversified portfolio that will generate returns over the long haul. On the other hand, tactical asset allocation is a more short-term approach that looks to take advantage of market conditions to generate higher returns in the shorter term. Both approaches have pros and cons, and ultimately, it is up to the individual investor to decide which is best for them.
More: How to diversify your investment portfolio
Tactical asset allocation step-by-step
As mentioned above, you may already be using TAA without knowing the term. It’s a multi-layered asset allocation plan applied to your investment portfolio. Here's how you can use TAA in a single account or across all your investments:
- Choose a portfolio asset allocation: Start by choosing your high-level target asset allocation. This is likely a split between four main categories: stocks (equities), bonds (fixed income), cash and equivalents, and alternatives. Empower’s free investment analysis tools help calculate this automatically if you don't know where you stand.
- Choose allocation within asset classes: Within your stock portfolio, you can choose to allocate in several ways. Some allocation buckets to consider are large cap vs. small cap stocks, investments in the United States and other regions, focusing on an industry you expect to outperform the market, or looking for quickly growing companies before other investors notice them.
- Pick specific investments: Now it’s time for the nitty-gritty of choosing your particular investments. Whether you want to invest in funds, single stocks, or something like Fundrise or Masterworks, this is where you make those decisions.
- Monitor and adjust as needed: This isn’t a set-it-and-forget-it investment strategy. At the same time, you don’t have to make daily or weekly adjustments. As a TAA investor, checking in and tweaking your targets monthly is important to keep your investments on track.
Adding tactical asset allocation to your portfolio
To include TAA in your portfolio, follow the steps above and organize your investment plan by asset class and your chosen sub-classes. Follow economic and business news to pick the proper allocation for your risk tolerance and investment goals.
If you’re feeling overwhelmed, you don’t have to start with your entire portfolio. For example, you can consider only your active investment account and then expand to other accounts and parts of your investments. Some investors may only want to use TAA in a taxable investment account, while others may apply it to retirement plans.
Also, remember that active investing and stock picking are not for all investors. If you don’t feel comfortable employing TAA for any reason, consider a more passive investment strategy, investing with a robo advisor, or working with an investment professional.
More: Robo advisor vs. financial advisor
Tactical asset allocation example
If you’re ready to dive in, here’s an example to help you along. Remember, this is a generic example that may not be appropriate for your investment needs; your ultimate investment decisions are up to you.
Brett decides to employ tactical asset allocation in his active portfolio, which makes up about 20% of his total investments. He starts by picking an allocation for what he believes is an upcoming period of stock market growth:
- Stocks: 70%
- Bonds: 15%
- Cash: 10%
- Alternatives: 5%
From there, Brett sets target allocations in each of those areas. For stocks, he breaks his investments into about a dozen different segments and picks a set of stocks and funds that match those categories.
For bonds, he decides on four different low-cost ETFs. In the cash portion of the portfolio, Brett buys short-term government bond funds that are readily convertible to cash. For alternatives, he decides on a new real estate platform he’s been wanting to try out.
While there is no one-size-fits-all solution, TAA can be a valuable tool for investors who are looking to add an element of active management to their portfolios.
Pros and cons
Pros
- A semi-active investment strategy that considers economic news and conditions
- Less work to maintain than an active single-stock portfolio
- It helps investors optimize risk vs. return
Cons
- Requires moderate investment knowledge to implement
- More time-intensive than a completely passive investment plan
- May underperform the markets
The bottom line
Tactical asset allocation is popular with professional investors for a reason. Virtually all investors look to make as much money as they can — that’s the point, after all! However, knowing how to do that while managing risk exposure isn’t always straightforward. TAA offers a strategy to help you know that you’re on the right track for your investment goals.
