Strategic Asset Allocation

Definition

Strategic asset allocation is an investment strategy that involves setting target allocations for various asset classes and regularly rebalancing the portfolio to maintain those targets over time. This method seeks to balance risk and return by diversifying investments across different asset types, such as stocks, bonds, and alternative investments, based on an investor's goals, risk tolerance, and investment horizon.

5 Must Know Facts For Your Next Test

1. Strategic asset allocation typically involves setting a long-term mix of asset classes based on an investor's specific objectives and constraints.
2. This approach is generally contrasted with tactical asset allocation, which focuses on making short-term changes based on market conditions.
3. Rebalancing is crucial in strategic asset allocation, as it helps to maintain the desired risk profile by adjusting the portfolio back to its target allocations.
4. The selection of asset classes in strategic asset allocation can significantly impact overall portfolio performance and risk exposure.
5. Investors often utilize historical returns, risk levels, and correlations among asset classes to determine their optimal strategic asset allocation.

Review Questions

• How does strategic asset allocation differ from tactical asset allocation in terms of investment strategy?
  • Strategic asset allocation focuses on establishing a long-term mix of asset classes based on an investor's goals and risk tolerance, while tactical asset allocation allows for short-term adjustments in response to market opportunities. In essence, strategic asset allocation is about maintaining a consistent investment philosophy over time, whereas tactical strategies involve actively shifting allocations to optimize returns based on current market conditions.
• Discuss the importance of diversification within the framework of strategic asset allocation.
  • Diversification plays a vital role in strategic asset allocation as it helps mitigate risk by spreading investments across different asset classes. By holding a mix of assets like stocks, bonds, and alternatives, investors can reduce the impact of poor performance in any single category. This balanced approach aligns with the objective of strategic asset allocation, which is to achieve a desired level of return while managing risk effectively.
• Evaluate the factors that influence the determination of an optimal strategic asset allocation for an investor.
  • Determining an optimal strategic asset allocation involves analyzing several factors including the investor's financial goals, risk tolerance, investment horizon, and market conditions. Historical performance data and correlations between different assets are also critical in this evaluation process. Ultimately, a well-defined strategic asset allocation aims to align the investor's preferences with their long-term financial objectives while minimizing risks associated with market volatility.

Related terms

Tactical Asset Allocation:

A flexible investment strategy that allows for short-term adjustments in asset allocations to capitalize on market opportunities or trends.

Diversification:

The practice of spreading investments across various assets to reduce overall risk and improve potential returns.

Rebalancing: The process of realigning the proportions of assets in a portfolio back to the original or desired target allocations.