From time to time we’ll be asked about making specific adjustments to a client’s portfolio. Often the questions are like the following:
What do you think about bank stocks? They’ve done poorly recently, should we be adding to them?
The economy doesn’t seem to be doing too well, what do you think about moving some of our riskier stocks to more defensive stocks?
I don’t like what the President/Congress/whomever is doing. What do you think about lowering the risk in the portfolio and adding to bonds?
These questions are examples of tactical asset allocation changes. It’s similar to market timing, but with a slightly longer time horizon (think of market timing as buying a stock right before earnings are announced in hopes of selling it afterwards for a quick profit).
Those who engage in tactical asset allocation are making changes to their portfolio based upon a change of expectations around investment returns or risks.
We do not practice tactical asset allocation in our management of our client’s investments. Below are some of the high-level key points against it.
- Following all of the market trends would be extremely time consuming and costly. To make that sort of commitment, we would need to be very confident it would be successful. Fortunately for you, we don’t need to try it out to see if it works, there are many financial professionals attempting this approach and we can study their results. A recent study compared the performance of 57 tactical allocation investments against a simple 60% stock 40% bond index (non-managed) investment. Not once did a tactical asset allocation investment outperform over 3, 5, 10 or 15 year periods1.
- Changes to investments requires additional trading which incurs trading cost as well as tax liability on capital gains in taxable accounts. There is a certainty of higher costs for tactical asset allocation but there is not a certainty of a benefit.
- Advocates of tactical asset allocation changes often tout their complex and sophisticated models without acknowledging that investment markets, just like the weather, cannot be fully explained by a model. We have three beliefs about the market that we believe represent reality much better than these models do.
Why are tactical asset allocation strategies popular?
Tactical asset allocation attempts to expand on the investing basic of buying low and selling high by using an outside metric to determine what high and low are. An example would be, if we know the financial sector is trading below historic price-to-earnings ratios, then it only makes sense to sell a sector trading above its historical price-to-earnings ratio to add to the financial sector. On its own, the logic is appealing. Here are a few other reasons we think the strategy is popular:
- It gives investors the illusion of control. The market is unpredictable, but making a trade based on the logic in the scenario above makes us feel more in control. Human beings like to be in control, even if it is just an illusion.
- The financial media makes us feel like we must act or we’re missing out. Remember, the financial media is not giving you advice, they are trying to entertain you so that you keep watching.
- The proverbial brother-in-law is making changes to his portfolio, shouldn’t you be? It may not be your brother-in-law’s idea either; over 60% of financial planners stated they either made an asset allocation change in the past 3 months or were currently re-evaluating their allocations2. We have some ideas on why that may be, but we’ll just say this: sometimes the best course of action is to take no action and that can be hard advice to give and receive.
One of our core values is a commitment to constantly be learning and expanding our expertise. We’ll continue our study of investment management techniques, but for now, we will not be making tactical changes to our asset allocation models.
1Source: “How ‘Tactical Allocation’ Mutual Funds Fared Over the Last Five Years” Luke F. Delorme. August 9, 2016.
2Source: Financial Planning Association 2012 Trends in Investing Study
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risk including loss of principal.
No strategy can ensure success or protect against loss.