Raffi PailagianMBA, BSc, DipFP
Adviser / Managing Partner
Before launching into developing your strategy, you may want to consider asking yourself these three basic questions, so key elements are not overlooked.
In our last article we talked about Modern Portfolio Theory and the Efficient Frontier. The key to success in using those theories is in the asset allocation, the art of developing target allocations by asset class, which can help focus your investment portfolio decision making. So how do you go about determining, and managing your asset allocation?
First things first. Before looking at what assets you want in your portfolio, you need to establish a few criteria by which you can evaluate your decisions. The best way to do this is to work with Financial planner to develop a Financial Plan or Statement of Advice. This Advice document will provide a roadmap for all future investing and will help you keep a clear head if the financial markets get rocky. Things you should cover in your Statement of Advice from an asset allocation and investment perspective include:
Once you have this statement, it is important to review it on a regular basis, to make sure the decisions you initially made are still relevant to your needs.
Traditionally there have been three main asset classes:
But in recent decades, additional classes have become popular. A well thought out financial plan is now likely to include:
Specifically which asset classes you should include in will depend on multiple factors, including the current market environment, investment horizon and financial goals, but in most scenarios, diversification across multiple asset classes is an optimal strategy.
There are essentially two main types of allocation, Strategic and Tactical:
This type of asset allocation is closely aligned with the passive investment strategy that we talked about in an earlier article. The important thing to watch is the differing returns by asset class, as this will ‘unbalance’ your allocation over time. So it is important to monitor your portfolio and, from time to time, rebalance where necessary.
You may also find that over time your financial roadmap or plan as documented in the Statement of Advice changes. This might be due to impending retirement, changes in your work situation or family dynamics. When this happens, it is important to look at your asset allocation and make sure it is still in line with your objectives.
This type of asset allocation is more like the active investment strategy that we mentioned. Whilst there is still an overarching strategic asset mix, an investor using Tactical Asset Allocation may temporarily change their asset mix to take advantage of opportunities that present themselves, often unexpectedly. The balance is then returned to the original mix once the short-term opportunity has passed.
Tactical Asset Allocation can also happen within particular asset classes. It may be that a particular company or industry sector is performing outstandingly well and you can adjust your levels of investment accordingly.
Some studies have shown that as many as 46%[i] of investors use Tactical Asset Allocation to take advantage of market trends.
Whether you are a high risk, high return investor who might wish to take advantage of tactical opportunities, or a more cautious investor who is more inclined to stick closely to their strategic plan, there is benefit in developing an Asset Allocation plan as it provides a focus for all investment decisions.
If you would like some advice on how to prepare your Investor Policy Statement, or to discuss how Strategic and Tactical Asset Allocation can help you meet your investment needs, please contact us on 02 9976 3388 or click below and we’ll be in touch.
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