Asset Allocation

balanced portfolio


Have an Asset Allocation Policy

“Divide your fortune into four equal parts: stocks, real estate, bonds and gold coins.  Be prepared to lose on one of them most of the time.  During inflation, you will lose on bonds and win on gold and real estate; during deflation, you lose on real estate and win on bonds, while your stocks will see you through both periods, though in a mixed fashion.  Whenever performance differences cause a major imbalance, rebalance your fortunes back to the four equal parts.”

– Jacob Fugger II (1459 – 1525) a wealthy German businessman who developed capitalistic economic concepts and influenced continental politics


When I think of asset allocation, I picture driving a car.  The more I press down on the gas pedal, the faster the car goes.  The same thing with having an investment portfolio – the more we have in equities, the higher the returns.  But the faster you drive, or the more we have in stocks, the more dangerous it gets as we experience greater portfolio value fluctuations.

The idea of having an asset allocation policy is to manage risk and keep you on the road to achieving your retirement goals.  It’s like having steering and brakes on the car with your spouse in the passenger seat yelling at you when you go too fast.  So, having a policy helps us to think not only of the potential returns on an investment, but also to put some limits on the degree of risk you’re taking.

What is Asset Allocation?

Asset allocation is the process of spreading, or diversifying, your investments across a range of different assets to minimize the risk of all your investments falling in value at the same time, and increase the potential for smoother and higher compounding returns.

The potential for higher returns comes through selling some of the winning assets (“selling high”) and using the proceeds to buy out of favour investments that have dropped in value (“buying low”).  Risk versus reward is considered in allocating investments to each asset class in order to design the portfolio to better match an your risk tolerance and returns required over time.

Most definitions on asset allocation are focused on dividing your portfolio amongst different asset classes.  The idea here is that assets in the same asset class share similar characteristics as to risk and return.  In other words, assets in the same asset class are correlated as they generally move up and down together in the same direction but to varying degrees whereas assets in different classes move more independently of each other.

For example, the prices of stocks (“equities”) and bonds often move in opposite directions: when stocks go up in value, bonds tend to drop in value.  In this case, stocks and bonds are negatively correlated.

By having assets in a portfolio that are not perfectly correlated, a diversified portfolio will have less overall percentage fluctuations than the weighted average fluctuations of the individual assets.

Conceptually think of the proverb, “Don’t put all your eggs in one basket”.  Dropping the basket will break all the eggs.  Placing each egg in a different basket is more diversified.  There is more risk of losing one egg, but less risk of losing all of them.

So we might think of an asset allocation policy as one that tells us the maximum number of eggs we are permitted to have in each basket.


Asset Allocation Policies

Having an Asset Allocation Policy provides guidelines to your investment professional as to how your portfolio will be managed.  And if you manage your own money, it serves as a reminder to you in making investment decisions on keeping risk under control.  Below are descriptions of the commonly used types of asset allocation policies:

  1. Strategic Asset Allocation

Strategic Asset Allocation (also called “Constant Weighting Asset Allocation”) calls for setting target allocations on different asset classes and then periodically rebalancing your portfolio back to those fixed targets as investment returns skew the original asset allocation percentages.

A simple way to implement this strategy is to set an equity target and keep to it through good times and bad.  Doing so can make you more money, compared to not rebalancing, over the long term.  But it takes real discipline.

When the stock market goes up, equities as a percentage of your entire portfolio will usually increase.  So, you sell stocks to keep to your target.  You resist the instinct to hold onto equities or even adding to them.

Similarly, when the stock market is falling, equities as a percentage of your overall portfolio has likely fallen.  Instinct tells us to sell equities and hide in cash or bonds.  But keeping to your equity target means buying more stocks when the market falls and bringing your portfolio back up to your equity target.

This strategy helps you to do better than not rebalancing as you are buying equities when they are down giving you the prospect to earn higher returns.  Similarly, you are also selling equities when they have run up.

This strategy works because the stock market fluctuates quite significantly from one year to the next.

Rebalancing can be done periodically – like say every six months or when the portfolio asset mix has deviated by a certain percentage.  For example, if you have a 50% equity target, you might rebalance back to 50% whenever equities become less than 45% or greater than 55%.

Under a Strategic Asset Allocation, your asset class targets normally don’t change unless there is a change in your anticipated needs through time.


  1. Tactical Asset Allocation

Strategic Asset Allocation can be very rigid, forcing you to have a fixed percentage in equities even when you anticipate the market to move up or down.

Tactical Asset Allocation is a strategy that “loosens the handcuffs” allowing for a range of percentages in each asset class so that you can, to a limited degree, adjust your portfolio to protect capital or to take advantage if you perceive market excesses or asset mispricings.

For example, if your equity target is 50%, Tactical Asset Allocation permits a range that you can have in equities from say as little as 40% in equities to a maximum of 60% in equities.  So, if you expect the stock market to decline, you can reduce equities to 40%.  Having a bottom limit forces a certain amount in equities as you may be proven wrong and the market rises.  Similarly, when you anticipate that the stock market will rise, you can then go as high as 60% in equities to take advantage.

If you have a skillful investment advisor, permitting him or her to do Tactical Asset Allocation can serve to reduce your portfolio risk and/or increase returns.  If your advisor doesn’t do well in weighting assets, this can lead to poor performance compared to Strategic Asset Allocation.


  1. Dynamic Asset Allocation

Dynamic Asset Allocation is like “throwing away the handcuffs”.  It involves regular adjustment of your mix of assets to take advantage of changing economic and market conditions.

The key thing here is that you have an awareness of the risks and potential returns and then, based on your view of the economy and market as well as specific assets, adjust the portfolio to protect your capital (by being more defensive) or to take advantage of any mispricings.

If you think the stock market is richly valued, you can significantly reduce equities to protect your portfolio.  And if the market then declines, you are not being forced to add to equities.  You can wait till it has turned or until you have confidence that the worst is over.  Then when you feel it is time to add to equities, you can add to the degree you feel comfortable.

Dynamic Asset Allocation recognizes that the level of risk of the market is not constant through time.  Consider a scenario where the stock market has dropped 20%.  The risk of the market declining substantially – say another 20% from this new lower level is much less.  When you feel the market has seen its low, it may now be a time where you can set yourself up for terrific risk-adjusted returns and take advantage to the level that you are comfortable with.



I normally work with clients where we have periodic reviews.  For each review, I produce a portfolio summary that shows the percentage exposure for each asset class and for each investment.  Our review includes a discussion of your situation and if anything has changed, your views and mine on the market and economy, and how we can adjust your portfolio given these perceptions, your needs through time and your risk tolerance.

In my experience, when working together like this with a family, this Dynamic Asset Allocation method of managing portfolio risk builds a portfolio that you become comfortable with which helps you develop an appreciation of the risks and return prospects.  And during times of market stress, you may be more likely to stick with your portfolio allocation as opposed to selling when the market is down which can lead to unrecoverable losses.

If you are unsure or unhappy with your portfolio allocation, maybe it’s time to get a no-obligation second opinion review of your portfolio.  I can be reached by calling: (604) 288-2083 or by email:

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