Strategic Asset Allocation (“SAA”) is the cornerstone of many investment strategies, often celebrated for its ability to balance risk and return. By establishing a long-term plan that diversifies investments across various asset classes, SAA claims to offer a healthy risk-reward ratio to investors.
However, while its foundational principles can be compelling in their simplicity, more discerning investors would do well to learn about hidden pitfalls that could undermine their financial goals.
This blog will explore three critical warnings that investors should think about when weighing up an SAA strategy with their investment adviser.
What is Strategic Asset Allocation? (Definition)
Strategic Asset Allocation is a practical investment philosophy that involves setting a target mix of different asset classes—for example, stocks, bonds, and real estate—in proportion to an investor’s risk tolerance, investment horizon, and financial goals.
Strategic Asset Allocation vs Tactical Asset Allocation
Unlike tactical asset allocation, which involves frequent adjustments based on live market conditions, SAA emphasizes a long-term, disciplined approach.
The allure of SAA lies in its promise of a balanced portfolio that can weather market volatility while providing steady returns. However, as with any investment strategy, SAA comes with its own set of challenges and risks.
Strategic Asset Allocation in Practice (Example)
But before we dive into those challenges and risks, let’s have a look at how an SAA approach could play out in practive. For our purposes, let’s assume that our prospective investor, “Mr. Young”:
- Had a total of $1 million to invest portfolio at the start of 2023;
- Is in their mid-30s (and therefore has a higher risk tolerance and a longer investment horizon); and
- Has a managed SAA portfolio that was active in 2023.
For an investor profile like this, a 70% equity, 20% bonds, 10% cash spread would be within the normal range, so let’s use those figures here. And let’s also assume that, throughout the course of 2023:
- Their equity holdings grew by 24% (in line with the S&P 500’s growth rate in 2023);
- Their government bonds offered a 5% yield; and
- They stored their cash in a high-interest savings account with a 5% interest rate (e.g. like the options here).
Asset Type | Strategic Asset Allocation (%) | Starting Value ($) | Growth Over 1-Year Period (%) | Value After 1 Year ($) | Allocation After 1 Year (%) | SAA-Required Adjustment ($) |
Stocks | 70% | $700,000 | 24% | $868,000 | 73.4% | (-) $40,222 |
Bonds | 20% | $200,000 | 5% | $210,000 | 17.7% | (+) $27,209 |
Cash | 10% | $100,000 | 5% | $105,000 | 8.9% | (+) $13,013 |
Total Portfolio | – | $1,000,000 | (18.3%) | $1,183,000 | – | – |
At the end of 2023, our hypothetical investor’s asset manager would need to redistribute the stock-bond-cash allocation to align with the original 70/20/10 split, which would mean reinvesting the “extra” growth from stocks back into more bonds and greater cash reserves (see the table above).
At the end of 2024, the same redistribution would happen, such that our investor maintained the 70/20/10 balance. This process would repeat itself each year until the investor and his financial adviser decided it was time to shift tactics (e.g. to a lower risk profile, with fewer stocks and more bonds).
All sounds pretty rosy and simple, right? Well, yes, actually, the theory is pretty simple. But for us, that’s where the problems start…
Warning 1: Oversimplification as a Sales Tactic
There is a huge difference between theory and application, especially when it comes to investment products. There are plenty of investment consultants out there who would be more than willing to sell you a product they claimed used SAA effectively, simply because SAA is fairly easy to explain to clients, and a relatively safe way to manage your money in the long-term.
In reality, however, terms like “Strategic Asset Allocation” can end up being a fancy smokescreen used to make you feel comfortable with a standardized sales offering, without actually offering you anything different from the next person. That doesn’t mean your portfolio won’t grow over time; it just means that you could be missing out on better, more personalized and creative opportunities.
Consider the 70/20/10 example we used above. Although these figures might be within the normal range in the industry, does that mean this rigid approach would be right for “Mr Young” for the next 10, 20 or 30 years?
Do you really think that robotically adjusting someone’s investment portfolio to align with these (somewhat) arbitrary numbers best serves the investor?
Or, perhaps, does its simplicity instead suit the investment advisor who has sold Mr Young the product, in that it makes their job easier?
SAA looks good on the surface, but what happens when you dig deeper?
Greg Liszka, IPF’s President, frames the problem prospective investors like Mr Young face as follows:
“Locally speaking, the only things people sell are American funds. It’s a commission sale. And they only have 20, maybe 24 funds to choose from. If you start opening the lid on those funds, they’re all very similar…The top 10 holdings on all of their stock funds? Shockingly similar.
So even if they’re going to offer you four different American funds, are you really getting four unique products? No! the core is the same. They have a different “flair” here or there, or whatever, but overall, it’s a legacy way of doing it.”
What this means is that, for the stock portion of your “SAA portfolio”, you end up getting almost exactly the same product as the next person, regardless of your age or investor profile.
In other words, you get something that is contrary to the very thing you signed up for (a “strategy that will suit your individual needs”)!
Although the theory behind SAA might affect the proportions accorded to your stock/bonds/cash split, that almost becomes “lip service” when you consider that the content of those allocations doesn’t change.
Warning 2: Neglecting Individualized Values & Needs
The appeal of an SAA aligned-product, as we mentioned earlier, is that it is supposed to acknowledge and meet each individual’s investment needs. But as we established with our first warning, this could be propaganda used to by an investment firm to take your money and make an easy commission.
The next layer — and the second warning you should be aware of when it comes to strategic asset allocation — is that it is designed to make you think you’re getting a tailored service, without questioning what that really means. Sadly, the SAA label can be used to redefine what should be a one-of-a-kind service into a generalized one.
In the wrong hands, SAA ends up justifying itself: “Because, Mr Young, you are in your mid-thirties, we believe you fit investor profile ‘x’, so to measure the effectiveness of this SAA-guided product, we’re going to benchmark your growth against a market index, and then you should magically be happy.” Notice how there is zero mention of Mr Young’s actual life, beyond their age and assumed risk profile?
When you contrast this with the truly individualized service firms like Iron Point Financial can provide, you start to see the difference. As Greg puts it:
“Instead of coming to clients and saying, “Hey, how much money do you have? $1 million? Great! Well, I really think ‘Growth Fund America’ would be perfect for you…”
I’d rather be about 1) planning together, 2) creating a personal roadmap, and 3) working down that, with something to fall back on, and clear goals to accomplish.”
In a word: it looks like a relational process rather than an automated one.
The Iron Point Difference: True Individualization
Let’s imagine that you wanted this kind of relational process for all of your financial planning needs by using Iron Point as an example. If you were to come in and work with us, you could expect us:
- To walk you through a rigorous evaluation process, in which we develop a deep understanding of your needs as a human being, not just as an idealized “investor”;
- To analyze your investment objectives so that we can co-create a comprehensive strategy to achieve your financial targets (not anyone else’s!);
- To create an invetment portfolio that accounts for both your short- and long-term objectives; and
- To actively monitor and adjust your portfolio based on your unique goals and life circumstances.
Everything this kind of service offers is based on human interaction, human needs, and human work. That doesn’t mean there is no technology involved, but it does mean that your unique needs drive the process.
Instead of you serving the technological system (in which you are just a number on a spreadsheet), the system in a personalized service is designed to serve you.
Warning 3: Ignorance of Creative Options
So far, we’ve focused on the ways the SAA label can confuse you into thinking you’re getting something that honors who you are as a human being, while ultimately serving the salesperson’s desire to make their job simpler, and to rake in an easy commission.
Our third warning is a little more positive: there are better, more creative options out there, if you’re willing to look for them — options that may still use the theory behind SAA, but require your adviser to do some hard work and research of their own.
In the example we laid out at the start of this article, we included three categories: stocks, bonds and cash. Why did we do that? Because those are the most common categories you will come across in the investment world. Why are they the most common? Because entry-level clients already understand them, so there’s no need for further education.
But what if there were a better way to apply SAA? What if the content of your “fixed-income” offering were a little different? This is the kind of thought process Greg likes walk IPF clients through:
“More often, the uniqueness comes in the desire for the safety side of things rather than the desire for growth. The growth story [stocks & shares] is, frankly, easier. But when people have a desire for regular income or safety, that goes way beyond saying, ‘How about we just give you some more bonds?’ That sounds intellectually lazy and boring to me.
These [alternatives] can be a little difficult to describe to people, so you try to educate them to the degree that they want to be educated. They involve employing different options and strategies like structured notes and certificates of desposit, which we can put together as a collection of different contracts, to achieve your desired outcome.”
Dual-Direction Structured Notes: A Creative Example
Consider the example of a “dual-direction structured note” (‘DDs’), which could be included in your portfolio instead of a bunch of bonds. As Greg explains, that contract works like this:
“Let’s say maybe we’re not feeling sure about the year ahead — perhaps it’s an election year, and maybe there are two-and-a-half wars going on the next hemisphere over…Whatever the geopolitical thing is, it makes people nervous. And you’ve got that floating through people’s minds, and maybe they’re getting close to retirement, so they’re worried about the downside.
One of my favorite options is the dual-direction structured note. It’s pretty cool stuff. It follows an index, or maybe two indexes. If it’s up, it’s up. And if its down, then anything down to, say, 20 or 25% will get you the absolute return of that number.
So if the index is negative 12% at the end of your period, you would be positive 12%. Even if everybody else is negative (the index is down), you get that positive outcome. That works because of how you structure the options, all the way down to a particular barrier (e.g. that 20 or 25% limit).”
Using an option like this, you could make the SAA approach truly creative, and truly appropriate for your circumstances, regardless of what’s going on in the world. It just requires your investment adviser to get creative, and to actively search out niche investment options, like we do at IPF:
“In the managed side, we’re really going to customize something for you, and then we’re going to monitor it. Depending on the strategy we’re employing, it could be weekly, it could be monthly. But we’re going to monitor it and make changes as conditions dictate. So you’re hiring us to actively do a job, not sell you something. We don’t want to sell you something. We want to fix a problem.”
Conclusion
Strategic Asset Allocation remains a valuable tool for constructing a balanced, long-term investment portfolio. As much as we would advise you to beware of the “strategic asset allocation” label as a way of (1) selling investment products, (2) ignoring your individual circumstances, and (3) reducing the workload of investment advisers, there is still much we can learn from its principles.
When you dig deeper and learn from firms that provide a truly personalized, truly creative service, then you can start to see how SAA theory can actively work on your behalf, and not the other way around.
Iron Point Financial serves the Greater Pittsburgh, Grove City, Greenville, Erie, Cranberry Township and Boardman, OH areas. If you are interested in a personalized service that uses Strategic Asset Allocation not as a sales product, but as one option among many that will serve your needs, why not reach out to Iron Point Financial today?
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Iron Point Financial is here to empower you to secure a brighter tomorrow. We operate physical offices in Grove City, PA and Greenville, PA.
We primarily serve residents of Pennsylvania, Ohio, West Virginia and Florida but we also have security registrations for 22 other states across the continental USA.
