In the complex and fluid world of investment strategies, tactical asset allocation (TAA) is a striking example of an active portfolio management technique that could maximize your returns at every twist and turn in the market — or at least that’s the theory.
Some — especially those who favor “strategic asset allocation” (SAA) instead — argue that the long-term risks of TAA far outweigh any potential short-term gains, while other investors tout TAA’s use as the key factor in differentiating their offering from other, less “exciting,” lower-yield options.
Conflicting voices aside, the question you should be asking yourself is: is tactical asset allocation right for me? Everyone’s investment needs are different, so it stands to reason that you should work through questions like this with your own, unique circumstances in mind.
Again, then: is TAA too risky to apply to your portfolio, or is it too lucrative not to include as an arrow in your investment quiver? The latest edition of Iron Point Financial’s blog aims to help investment enthusiasts like you grow a deeper understanding of how TAA could help you, what it could cost you, and how you might pragmatically and prudently use it with a healthy balance of risk and reward.
Conceptualizing Tactical Asset Allocation
Before jumping into the discussion of TAA’s pros and cons, we ought to define what tactical asset allocation is in the first place. Simply put:
Tactical asset allocation is a dynamic investment strategy whereby managers adjust a portfolio’s asset distribution to make the most out of short-term trends in the market.
So if, for example, your assets contained a mixture of stocks, bonds, and cash, and you wanted to employ tactical asset allocation, you would change the proportions of each asset type to match what is happening in the markets. Hypothetically, you might change a 30% stocks proportion to 35%, and a 55% bonds proportion to 50%, with the final 15% cash proportion staying the same, to make the most of accelerated growth in the stock market.
Unlike the more static, unchanging approach offered by strategic asset allocation, which relies on a pre-set, baseline spread of investments over different asset classes, tactical asset allocation is deliberately proactive and, where appropriate, reactive: its practitioners regularly fine-tune the proportion of their investments in a given asset class to minimize the effect of downturns on one class and maximize the potential for growth in another.
Setting the Debate Stage
The difference in underlying principles between TAA and its strategic counterpart forms the crux of the debate between the two “sides.” If you can understand this difference in values, you will be well-placed to decide whether it is right for you.
The first school of thought champions tactical asset allocation’s agility and responsiveness, and focuses on its potential to enhance returns for clients moment-by-moment. Plus, this school argues, TAA typically involves small, consistent, and reversible changes, rather than wholesale revolutions in asset proportions.
The second group — usually, TAA skeptics who hold up SAA as the gold standard — tends to question the reliability of TAA’s market-timing approach, stressing the associated, increased risks. The people in this camp believe that tactical asset allocation results in lower returns in the long run, even if they accept that TAA has the potential to offer a short-term payoff in some situations.
TAA's USP: Responding to Market Conditions
Perhaps the most compelling argument in favor of tactical asset allocation comes from those asset managers who have built up a track record of success with TAA above and beyond their SAA competition. They argue that their use of tactical asset allocation has allowed them to continue to ride the waves of short-term market fluctuations, and they point out that if investors are supposed to act in the best interests of their clients, then they should use every tool possible to capture investment tides like this on their behalf.
Moroever, they argue that engaging in this more active management style can bring a level of expertise to its practitioners over time: the more you use TAA, the better you may get at observing big-picture market conditions and maximizing gains for your clients. The more small wins you build up using TAA, the greater your long-term gains can be, notwithstanding SAA advocates’ primary critique.
Perspective 1: Proponents of Tactical Asset Allocation
Dancing with the Market
This live element is what can make tactical asset allocation so alluring and intriguing. You could almost describe the use of TAA as a “dance” with the markets: pirouetting into profitable niches while nimbly sidestepping dangerous downturns.
The ability of investors who use TAA to “think on their feet” has allowed some of them to bolster returns even in the midst of economic uncertainty, volatility and bubbles— as they are actively and intelligently embracing the ebb and flow.
Real-World Success
Perhaps the most striking and fruitful example of tactical asset allocation in recent memory was the decision by some asset managers to shift their portfolios away from equities and into bonds… prior to the 2008 financial crisis — mitigating significant portfolio losses in the process.
Managers like these tactically observed that underlying weakness in the US housing market could have considerable knock-on effects for banks that offered sub-prime loans to those with poor credit ratings. And they reasoned that if the banks were due for a hit, the same could be true for the rest of the stock market. Their decision to shift from stocks to bonds severely lessened the blow for their clients, unlike the rest of the world.
Perspective 2: Critics of Tactical Asset Allocation
The Double-Edged Sword of Market Timing
The dynamic nature of TAA is also its main weakness. For every TAA success story, there are just as many, if not more examples of funds that have underperformed in the wake of poorly-timed decisions.
Those with a dim view of tactical asset allocation have pointed out that efficiently timing TAA to accord with the market is difficult at best, and impossible over time at worst. They point to consistent evidence that the majority of TAA-grounded mutual funds fail to outperform SAA-oriented ones over extended periods.
In their view, precisely what makes TAA so attractive — the romantic idea of “dancing with the market” — is what leaves its clients at the greatest risk of financial injury. This is particularly pertinent when you consider that clients of tactical asset allocation funds often:
- Pay higher premiums for the privilege of having a “brand-name,” “track record” manager look after their portfolio; and
- Lose money through the added transaction costs associated with too many tactical asset allocations (fees paid to brokerages, etc., in the course of shifting asset balances);
As a result, critics can meaningfully argue that TAA is just too expensive to consider as a viable option: the associated extra costs, in the long run, end up eating into any potential short-run gains, especially in tax-sensitive portfolios.
The Risk of Overreaction
Not only can the costs be prohibitive, but the financial maxim that “experience does not guarantee success” can be even more true with tactical asset allocation, given that each compounding TAA-based decision increases the risk to a given portfolio.
Why is that? Because greater complexity invites a greater probability of error. One good decision does not ensure that the next one will work out — and in fact, the confidence boost that comes from one or two good tactical asset allocation choices could actually lead to overconfident over-adjustment where too much weight is placed on anecdotal or short-term indicators.
Perspective 3: Neutral Ground and Practical Considerations
Seeking Balance with Iron Point Financial
So where might this leave you? Should you be forced to choose between strategic asset allocation and tactical asset allocation only? Is the dichotomy really that rigid?
At Iron Point Financial, we would argue that there is a way to “get the best of both worlds,” if your starting principles are a little different. We believe in sitting down with each client, and tailoring our advice and offering to suit your unique situation and risk tolerance.
That means that if you have a higher tolerance and you want us to actively seek out short-term opportunities on your behalf, TAA could prove to be one useful tool among many for supporting this aim. In that case, we would suggest a measured, judicious use of TAA where we feel it could add value. That does not mean we would hinge your entire portfolio on tactical asset allocation, but we would not outright exclude its use, either.
Equally, if you felt more comfortable with a lower-risk, more moderately rewarding long-term approach, we could create an investment structure that suits that goal, too — it all depends on your whole-life needs and preferences.
Closing Thoughts
As with all things in the investment world, you have likely surmised that tactical asset allocation is neither a silver bullet nor a disaster waiting to happen. Dogmatic thinking can only get you so far, and we have learned that it is best to meet each individual where they are at.
As such TAA could prove a powerful tool in your arsenal, when used sparingly, or it could be something you’d rather steer clear of completely — it’s up to you! Just know that if you ever need help on your investment journey, with tactical asset allocation or anything else, Iron Point Financial will be on hand and ready to serve you with dialogue, diligence and specificity.
Further Resources
- How to Find and Investment Consultant: 5 Things to Look For
- 3 Crucial Ways Holistic Financial Planning Can Help You
- Margin Loans: 8 Potential Benefits and Risks
- Target Date Funds: 5 Crucial Reasons to Avoid Having One in Your 401k
The views stated are not necessarily the opinion of Cetera and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice.
Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
Asset allocation, which is driven by complex mathematical models, should not be confused with the much simpler concept of diversification.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
