Strategic asset allocation is an investing tactic that was inspired by Markowitz's theory. The creation of a balanced and robust portfolio is the primary objective of the strategic asset allocation.
To do this, investors select a combination of investments that adapt to changing market conditions in different ways. Depending on their financial objectives, time horizons, and level of risk tolerance, investors choose different asset classes and allocate different amounts of capital to each.
Strategic asset Allocation strategy should be examined and rebalanced on a regular basis to ensure that it remains consistent with the investor’s goals and risk tolerance.
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When the asset allocation weights deviate considerably from the strategic asset allocation weights due to unrealized gains/losses in each asset class, rebalancing occurs.
Strategic asset allocation is the process of constructing an ideal long-term portfolio (5-10 years) by asset class, based on long-term expected returns.
Strategic asset allocation is the most important driver of long-term return stability. It explains more than 75% of the volatility in returns with security selection.
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Retail investors are typically more concerned with the short term. Market trading opportunities abound as a result of the most recent economic, financial, or political news. Nothing is wrong with that.
However, if you need to develop a portfolio with a long-term return objective, you should also define a strategic asset allocation methodology. Long-term investing and short-term trading can complement each other.
Example- Strategic Asset Allocation
Rahul stated in his investment policy statement that he prefers a strategic asset allocation of 60% stocks, 30% bonds, and 10% gold. Rahul's portfolio is worth ten lakh rupees, and he rebalances it annually.
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His portfolio at the start of the year looks like this:
| Asset Class | Weight | Portfolio |
|---|---|---|
| Equity /Stock | 60% | 6,00,000 |
| Debt | 30% | 3,00,000 |
| Gold | 10% | 1,00,000 |
| Portfolio Value | 100% | 10,00,000 |
After 1 year, equities generated a 12% return, Gold generate 8%, and bonds generated a 6% return.
The following is Rahul's unbalanced portfolio:
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| Asset Class | Weight | Portfolio |
|---|---|---|
| Equity /Stock | 61.20% | 6,72,000 |
| Debt | 28.96% | 3,18,000 |
| Gold | 9.84% | 1,08,000 |
| 100% | 10,98,000 |
For Rebalance portfolio, Rahul sell equity portion 13,200 & added in Debt 11,400 & Gold 1,800.
| Asset Class | Weight | Portfolio |
|---|---|---|
| Equity /Stock | 60% | 6,58,800 |
| Debt | 30% | 3,29,400 |
| Gold | 10% | 1,09,800 |
| 100% | 10,98,000 |
To maintain consistency in the allocations, investors frequently rebalance their strategically allocated portfolios on a regular basis.
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This is due to the possibility that the initial allocations may become unbalanced in the long run as a result of the variations in returns from each asset class.
The most crucial investing choice a person makes is strategic asset allocation.
It has shown to be successful, but it needs that investors stick with it and avoid making rash, emotional decisions based on the market's current condition.
