Strategic asset allocation is a method of balancing an investment portfolio over time by periodically realigning the proportions of assets. This process, known as rebalancing, is essential for maintaining the desired risk-return profile of the portfolio. In this article, we will explore three diverse, practical examples of strategic asset allocation rebalancing to enhance your investment strategy.
In this example, an investor adopts a balanced approach, aiming for a portfolio that consists of 60% stocks and 40% bonds. The investor believes that this allocation strikes a good balance between growth and stability.
After one year, the market has performed well, and the portfolio has increased in value. The stock portion now represents 70% of the total portfolio, while bonds have decreased to 30%. To restore the original allocation, the investor sells a portion of the stocks and purchases bonds.
By rebalancing, the investor mitigates the risk of being overly exposed to equities, ensuring alignment with their risk tolerance and investment goals. The key takeaway is that periodic rebalancing can help maintain the desired risk level and prevent emotional decision-making.
In this scenario, a retirement plan participant invests in a target date fund with a planned retirement date of 2040. The fund automatically adjusts its asset allocation over time to reduce risk as the target date approaches.
Initially, the fund might be allocated 80% in equities and 20% in fixed income. As the target date nears, the allocation shifts to 50% equities and 50% fixed income. If the equity markets perform exceptionally well, the allocation may unintentionally shift to 90% equities and 10% fixed income.
To rebalance, the fund manager would sell some equities and buy fixed income investments to realign with the target percentage. This automatic rebalancing helps participants stay on track with their retirement goals without needing to make manual adjustments.
A more advanced investor employs a tactical rebalancing strategy, using market indicators and economic forecasts to make adjustments. This investor starts with a 50/50 allocation between domestic and international equities.
After analyzing market trends, the investor identifies that international equities are likely to outperform domestic stocks over the next year. The investor temporarily shifts the allocation to 60% international and 40% domestic equities. After six months, if the international equities have indeed performed better and now represent 70% of the portfolio, the investor decides to rebalance back to the original 50/50 split.
This approach allows the investor to capitalize on market opportunities while maintaining a disciplined rebalancing strategy that aligns with overall investment objectives.