Tactical Asset Allocation Strategies in Mutual Funds

Meaning of Tactical Asset Allocation

Tactical asset allocation is a strategy through which you shift your original asset allocation in a manner that takes advantage of market opportunities. In this type of asset allocation, you adjust your mutual fund investments in a way so that you adjust your portfolio as per the prevailing macroeconomic factors. Let’s understand it with an example.

Suppose, your original mutual fund asset allocation is 70% into equity and 30% in debt. With equity markets performing well, you feel increasing your equity allocation to 80% can boost your wealth in the short term. To capitalize, you increase your equity allocation to 80% and bring down debt to 20%. After making the desired gains, you shift back to the original allocation of 70:30.

Advantages of Adopting a Tactical Asset Allocation

Adopting tactical asset allocation in mutual funds brings several benefits to the table. These are the benefits you get when you follow this strategy:

1. Earn Potentially Higher Returns

A key objective of mutual fund investment is to earn higher returns than traditional fixed-return instruments. Tactical asset allocation aids you to earn potentially higher returns in a rising market. The extra kicker at different times can significantly affect the final corpus.

2. Protect Gains

Tactical asset allocation is about earning higher returns and protecting the gains. When equity markets are overheated, it makes sense to shift to debt to protect the gains. With tactical asset allocation, you can protect your gains from getting eroded due to market volatility.

3. Achieve Diversification

Diversification is one of the fundamental investing tenets. It’s an effective risk mitigation tool that provides stability to your portfolio and ensures its performance isn’t dependent on the performance of a single asset class. Tactical asset allocation helps you achieve the much-desired diversification by spreading your mutual fund investment across various categories, including equity, debt, and exchange-traded funds (ETFs), among others.

Disadvantages of Tactical Asset Allocation

While tactical asset allocation has its advantages, it has certain disadvantages, too. These include:

1. Risk of Market Timing

A significant part of your success with tactical asset allocation hinges on how well you can time the markets and make the necessary adjustments. Market timing is easier said than done. Even the most seasoned investors can’t predict market movements accurately. Therefore, time in the market is more important than timing the market.

2. Emotional Decision Making

Tactical asset allocation can lead to emotional decision-making. You may be prompted to invest more or reduce your investments based on short-term market performance. More often than not, emotional decision-making backfires and can hurt your investments.

At the same time, constantly churning your asset allocation doesn’t guarantee outperformance. Frequent chopping and churning of your portfolio can lead to underperformance as against the buy-and-hold strategy. Inconsistency in outcomes can lead to frustration and dissatisfaction.

The Final Word

Tactical asset allocation needs a high knowledge of markets and constantly monitoring them. Though it has the potential to offer higher returns, you need to be always on your toes and be extremely proactive to make the most out of it. If you have the time and resources, go for it. If not, it’s better to stick to the buy-and-hold strategy.