By Jeff Terrell, CFA

scale with money on the left and other types of securities on the right

Finding the right balance of stocks, bonds and other assets to help you achieve your goals can feel elusive. Designing an ideal asset allocation plan that considers the unique dynamics of each market cycle can present many challenges, but those challenges can be overcome by adapting to change while employing the right tools and technology to provide a smoother ride.

For starters, there are two basic types of asset allocation (AA).

Strategic Asset Allocation – This most basic form of AA is the foundation for an investor’s personal investment policy statement with targeted allocations to stocks, bonds, cash and diversifying assets.

Dynamic Tactical Asset Allocation – Active asset allocation is the single most important tool in an investor’s toolbox. Making tactical range-bound adjustments to your strategic targets as economic and market dynamics change can have the greatest positive impact on a portfolio over a full market cycle.

Three key rules of the road:

  • Your big picture – Asset allocation must also consider your asset location. When developing an asset allocation plan for a particular account (such as an IRA) do so with respect to all of your investment accounts and trusts within the context of your overall investment plan.
  • Proactively adapt to change – What has worked in the past may not work as well in the future. Three primary shifts in the last 15 years have had profound implications for asset allocation:
    1. Low interest rates: Global interest rates have been cut by more than half over the last several years. Bonds retain their risk reduction qualities to balance volatile equity assets, but they are not the same total return vehicle they were 10 years ago. Bonds remain a critical component of any AA plan, but their role and expectations have shifted.
    2. Globalization: Twenty-five years ago U.S. and international stocks balanced one another often moving in opposite directions or differing magnitudes providing broad diversification opportunities. Today, global economies have converged with even the S&P 500 index of companies generating 40% of their revenue from foreign sources. As a result, correlations between U.S. and international markets have more than doubled making diversification more difficult and opportunistic international investing more preferential.
    3. Volatile Risk Regimes: Aversion to loss and volatility are the basic contexts in which most people think of risk. Markets have experienced periods of quiet volatility, like 2017, and periods of turbulent volatility, like 2008. During periods of turbulence, diversification becomes challenging as many riskier asset classes all move in the same volatile direction.
  •  Asset allocation does not work every time, but it does work over time. The chart below considers the bull and bear market cycles we have seen since the bursting of the dot-com bubble in 2000 through year-end 2018. It may surprise some to learn that a fairly simple diversified portfolio of stocks and bonds outperformed the S&P 500 (106% of the return) at far less volatility risk (64%). Though it is true the S&P 500 has had more explosive growth during bull market phases, it is also true it had to make up ground for bad bear markets. The S&P 500 is shown in red and the diversified portfolio is shown in orange.

chart of S&P 500 vs a diversified portfolio

In this example, the S&P 500 was like riding a big roller coaster whereas a diversified portfolio was like riding the small roller coaster. Each delivered you to roughly the same destination, but one caused less heartburn along the way.

A thoughtful investment policy that defines the purpose of your portfolio and the role of each asset class with changing risk regimes is essential toward fulfilling your goals. Our purpose-driven approach to asset allocation is designed to help arrive at your final destination with fewer obstacles along your journey.

Proactive practices to implement dynamic tactical asset allocation:

  • Broaden the selection of distinct less correlated asset classes (including less traditional asset classes) in your asset allocation plan to offer balanced diversification in times of turbulence.
  • International investing has become more about being opportunistic than mitigating risk through diversification. Seek tactical opportunities with conviction views of the most attractive markets and currencies to complement a core U.S. equity portfolio.
  • Correlations among asset classes are not always stable and can vary widely during times of market stress such as 2008. Conducting a regular reassessment of changing risk views and rebalancing accordingly is always appropriate.
  • Use technology to anticipate economic and market trends rather react to recent past events. This is like a quarterback throwing the ball to where a receiver is going, not where he has been.

About the Author

Jeff Terrell, CFA

Jeff Terrell, CFA

Senior Vice President, Chief Wealth Market Strategist

Jeff is a Chartered Financial Analyst (CFA) with more than 20 years of bank chief investment officer experience. He specializes in dynamic asset allocation and portfolio construction. Jeff is the author of BB&T Wealth’s Market Monthly and Market Spotlight and leads BB&T Wealth investment communication efforts.