Asset Allocation Strategies
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Asset Allocation Strategies
There are two basic asset allocation strategies—passive and active. Passive allocation is a strategy in which the investor does little to alter his or her mix of investments once established. This strategy can be thought of as a buy-and-hold philosophy. Many investors correctly believe that the longer an asset is held, especially one with a history of price volatility, the less chance that asset will turn in a negative performance. Therefore, a passive allocation strategy establishes a broad mix of investments that are consistent with the investor’s objectives, then holds those assets for long periods of time, trusting that the highs and lows will balance out to an acceptable return over time.
Things To Know
- In passive allocation, one’s portfolio changes little.
- In active allocation, investments are allocated many times to increase portfolio returns.
How active allocation works
By contrast, active allocation is a strategy in which investments are allocated and reallocated perhaps a number of times in an effort to increase portfolio returns. With active allocation, the investor maintains the original percentage weighting given to each asset class. In other words, while both allocation methods establish initial positions that are consistent with the investor’s objectives, the active allocation proponent will subsequently reallocate. This will be necessary as fluctuating asset values alter the original allocation percentages, in response to market or individual investment changes. Some criteria used in deciding when (and when not) to reallocate include price volatility, performance, interest rates, and changes in investment management.
Active allocation usually costs more
As you can probably guess, active allocation can be more costly than passive. While both strategies may cost virtually the same to initially establish, active allocation can be considerably more expensive. This is because each reallocation can result in the liquidation of shares of one or more individual stocks or mutual funds in exchange for shares of new stocks or mutual funds. And each time there will be trading costs and sales charges, or both, to pay.
