Asset Allocation vs. Tactical Allocation – Know the Difference

Asset Allocation is being mistaken form tactical allocation. “It’s the financial fantasy for a post-crash world: Wouldn’t life be grand if you could own one mutual fund that invested in domestic and foreign stocks, bonds, cash, real estate, commodities and currencies, freely shifting investments among categories to take advantage of opportunities, and avoid meltdowns?”

Well, of course it would. Fund companies, including PIMCO, Legg Mason, and Van Kampen, say they’ve got just the thing for you: They are called tactical asset allocation funds, and a new one seems to roll out daily. Don’t believe the pitch. No manager can predict the future of one asset class let alone multiple ones. Yet terrible odds have not kept these new funds from becoming the trendy way to invest. So what is technical asset allocation and why is it dangerous?

How It Works

Tactical allocation requires managers to predict which asset classes will lead and which will lag, and then to own securities that will benefit. Needless to say, they don’t always get it right. But that doesn’t stop some of them from charging high expenses or keeping their investing strategies opaque or both. This approach may sound like market timing, the discredited investment strategy of jumping in and out of a market to catch upswings and avoid downturns. But tactical fund managers prefer a more nuanced explanation of their approach. They typically hold a wide range of assets, overweighting classes they find most appealing and underweighting ones they consider overpriced or otherwise undesirable. Some choose allocations based on technical indicators, others on fundamentals. Sounds great, doesn’t it, but unfortunately it simply does not work over the long-haul. Portfolio diversification, however, is an investment strategy employed by leading institutions and endowments and is a great approach for retirement. Unlike tactical allocation, asset allocation focuses on using low-cost, tax-efficient index funds in specific target percentages that are rigorously maintained through rebalancing as markets shift.

Why It Is Dangerous

Research conclusively demonstrates that only a small percentage of managers will beat any one index in any given year. When you examine fund managers’ performance vs. the index out ten years, the winners drop into the low single digits. Now imagine asking a fund manager to not beat one, but four, five or six indexes all at the same time. Statistically, your likelihood of success drops into a fraction of one percent – probably not the best bet for your retirement.