At Financial Freedom Fee-Only Wealth Management, we have a three-level approach to investment management. Level one is strategic asset allocation.
The basic principle behind this investment strategy is that you are investing long-term in a number of different asset types or classes (such as stocks and bonds).
Depending on how those different assets return, the portfolio is rebalanced periodically back to the original asset allocations that align with your own specific goals, which are set using your overall investment timeline and tolerance for risk.
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Read on for more information on strategic asset allocation as part of the investment management services that Financial Freedom Fee-Only Wealth Management offers:
How Does Strategic Asset Allocation Work?
Strategic asset allocation works by applying the basic principles of the Modern Portfolio Theory (MPT). This theory states that markets are overall efficient over time and keeping a static path with your asset allocation will be a better long-term bet than making decisions based on trying to predict which direction the markets are going to go or investing in the ‘next big thing’.
This theory also aims to prevent emotional short-term decisions based on current market or political events by staying the course and riding the ups and downs of the market which – according to this theory – are steady enough over time to meet your investment goals.
A good plan for strategic asset allocation takes into consideration the expected risk levels and returns for each asset class. An asset class is simply another name for a grouping of similar types of investments such as stocks, (equities) bonds (fixed-income investments), cash or cash equivalent investments, real estate or futures. Each asset class comes with its own risk level and of course, potential for gains or losses.
Diversification is an investment strategy all on its own, but in the setting of a strategic asset allocation plan, it’s an important tool for minimizing risk exposure. By allocating your assets into different types of investments, investors are not left exposed to any one investment or risk.
In the case of an underperforming investment, this could decrease your risk for loss. Conversely, this can also limit your returns on a higher-performing investment, but such is the nature of investing. Without the ability to predict the future of the markets, it’s all about calculating risk and reward and making changes when appropriate.
Because diversification is at the heart of the strategic investment allocation strategy, diversification is something your financial advisor will be able to help you achieve and maintain.
Determining Your Risk Tolerance
Determining this risk tolerance ahead of investing is all part of the strategic asset allocation plan. Once you know your tolerance for risk, you can plan out your asset allocation within a strategic asset allocation plan accordingly.
You’ve no doubt heard the phrase “the greater the risk the greater the reward,” and this can be true in the investment space. For example, if you’re close to retirement and have amassed a large portfolio, you are going to be more risk-averse than someone who is younger and has many more investment years ahead of them to make up for any potential losses from high-risk, high-reward investments.
Determining this risk tolerance ahead of investing is all part of the strategic asset allocation plan. At Financial Freedom Fee-Only Wealth Management, we believe your overall asset allocation should be driven by what we call “your sleep comfort level” which takes into account your desire for volatility, risk tolerance, as well as what requirements are needed from the portfolio.
Typically, when utilizing strategic asset allocation, there is a finite amount of time before you will need to access the funds you’re using to invest. This timeline is usually based on when you plan to retire.
When initially structuring your strategic asset allocation, you and your financial advisor should take many things into consideration, including your age, risk tolerance, and goals for your overall portfolio.
From there, you can make a plan on where you can take some risks and where you should play it safe. This plan will also include recommendations for when to rebalance your plan if the percentages have skewed one way or the other based on market conditions and other factors.
Monitoring and Rebalancing
Depending on when you set up your strategic asset allocation, you will likely need to make adjustments over the life of your investments. That’s because like most things, over time, your circumstances and goals may change because of your life circumstances, market fluctuations (or both!)
It’s very likely your investment allocation will need to be restructured to get back to your original asset allocations because of higher-performing investments in some areas and lower-performing investments in others.
The whole goal of strategic asset allocation is to maintain the original balance of investment types to stay the course and reach your ultimate financial goal. Depending on the situation, your financial advisor will work with you to monitor your strategic asset allocation plan and decide how frequently it should be rebalanced to maximize its efficiency and your returns.
Strategic vs. Tactical
The main difference between strategic and tactical asset allocation is one of timing. Whereas strategic allocation is generally set with a long-run target, tactical allocations can be made with more frequency based on market or other conditions.
In terms of tactical allocation, at Financial Freedom Fee-Only Wealth Management we allocate using six primary asset classes: large cap, small cap, mid cap, international, energy/natural resources, and real estate. Additionally, we also focus on several key business segments such as health care, technology, and financial services.
Finding the Right Financial Advisor
Strategic asset allocation is about more than simply finding the right formula for maximum returns. Finding the right investment strategy starts with a conversation between you and your financial advisor to make a timeline, execute, and achieve your goals.
And because every investor is different, a one-size-fits-all investment strategy that simple plugs numbers into an equation simply won’t work for all investors without identifying your personal goals, risk tolerance, time horizon and other factors that make your situation unique.
At Financial Freedom Fee-Only Wealth Management, we have over 30 years of experience working with high-net-worth individuals and couples. We are a fee-only, fiduciary, wealth management firm dedicated to helping our clients protect, grow, and maximize their wealth.
Contact us today for a complimentary consultation, and find out if we are the right fit for your needs.