Amid the ruins of the last market meltdown of 2008-2009, you’ll find the finance theory of Asset Allocation and the idea that all an investor needs to do is ‘Buy and Hold.’ As good and practical as that advice is, it was awfully hard to avoid the emotional panic created by such an extreme. So investors and financial advisers like me were put to the test about our beliefs in the idea of ‘efficient markets,’ ‘modern portfolio theory’ and ‘Buy and Hold investing.’ We started to ask ourselves: Is there a better way?
For retirees, I think that the answer is yes, your asset allocation should be more tactical. So I have adopted tactical strategies with the MarketFlex portfolios created here at Clear View as a way to help hedge client portfolios. Here’s my reason why.
The meltdown was hard for all investors, especially retirees, many of whom questioned their game plan amid huge losses. Sure, market volatility tests the resolve of buy-and-hold investors and in many cases increases the appeal of tactical asset allocation. And sure, it’s fine to say that you shouldn’t panic since ‘this too shall pass.’
But I’m a realist (though I used to be more of an idealist but that was before getting beat up by unpredictable markets and people over the years). I’ve lived through more than one market meltdown. I’ve seen the devastating impact on the retirement plans of many who worked at places like Enron and WorldCom. Closer to home, in the Boston and Merrimack Valley areas in particular, I’ve seen employees at such giants like Wang, Digital and Lucent go from being millionaires on paper to being nearly penniless. I’ve seen these same folks have to cancel their dreams, adjust their plans and defer retirement for years.
I don’t want to see this happen again to anyone, especially retirees. While most investors can survive a little blood-letting every now and again in the markets, the timing of a bad set of returns for someone who no longer has a steady paycheck coming in and has less time to recover than someone who is employed means the possible difference between retiring well or having to get a job as a Wal-Mart greeter.
So using tactical management is a way to help protect a client’s portfolios. I don’t think it replaces a core strategic asset allocation but enhances it.
Strategic versus Tactical Asset Allocation: What’s the Difference?
Strategic Asset Allocation (SAA) is based on widely practiced modern portfolio theory: the portfolio into an array asset classes which are not strongly correlated. The allocation is based on your risk tolerance and the long-term risk and return characteristics of each asset class. SAA periodically rebalances asset allocation based on pre-set target allocations. It only makes major allocation changes if a major life event occurs such as retirement, marriage, or college.
Tactical Asset Allocation (TAA) is a much more active portfolio management strategy. Portfolio composition and weightings are altered in the short-term to take advantage of perceived differences in relative values of various asset classes. In some cases, the allocation changes are based on signals provided by the near-term pricing history, trading volume and trends of a particular asset class, specific investment or sector.
While tactical asset allocation may look appealing on the surface, it is best left to investors who understand its complexity or at least professionals who can do this for you. Otherwise, this strategy could leave investors stuck with an asset allocation that may be unsuitable for their goals, risk, and liquidity requirements. It is also important to keep in mind that active trading increases both taxes and transaction costs. In this case, it’s best employed through one’s tax-deferred or tax-free retirement accounts.
The bottom line: Pick a strategic portfolio plan with an appropriate asset allocation for your time horizon. Your individual portfolio should address both your immediate and intermediate needs. Get help from a qualified financial planner to determine if your investment plan is right for you. And if you’re concerned with limiting the damage caused by market corrections, then adopt a tactical overlay to your core plan. With the right plan in place, your portfolio will be better equipped to handle volatility, allowing time to smooth out the choppy returns.
There is no guarantee that either strategic or tactical asset allocation will protect against market risk. These investment strategies do not ensure a profit or protect against loss in a declining market. Please keep in mind that diversification does not eliminate the risk of experiencing investment losses but it may help mitigate the risk.
For a second opinion or specific advice with your personal situation, give me a ring at 978-388-0020 or 617-398-7494.