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Asset allocation is the single most important decision you'll make as an investor—research consistently shows it explains over 90% of portfolio return variability over time. When you're tested on this material, you're not just being asked to define strategies; you're being evaluated on your understanding of risk management, time horizons, active versus passive management, and how investors balance return potential against downside protection.
These strategies represent fundamentally different philosophies about how markets work and how investors should respond. Some assume markets are efficient and favor a "set it and forget it" approach; others assume skilled managers can exploit inefficiencies through active adjustment. Don't just memorize the strategy names—know what problem each one solves, who it's designed for, and how it handles the risk-return tradeoff.
These approaches establish predetermined allocation targets and maintain them over time. The core principle is discipline—removing emotion from investment decisions by committing to a systematic framework.
Compare: Strategic vs. Constant-Weighting—both maintain fixed targets, but constant-weighting emphasizes regular rebalancing while strategic allocation tolerates more drift. On an FRQ about maintaining risk exposure, constant-weighting is your stronger example.
These strategies involve modifying allocations based on market conditions, economic forecasts, or portfolio performance. The underlying belief is that markets are not perfectly efficient and skilled managers can add value through timing.
Compare: Tactical vs. Dynamic—both involve active adjustment, but tactical allocation makes opportunistic moves while dynamic allocation makes systematic responses to market conditions. If asked about responding to a market crash, dynamic allocation is the more relevant framework.
These approaches prioritize managing portfolio risk rather than simply chasing returns. The key insight is that traditional allocation by capital (dollars) doesn't account for how much risk each asset class contributes.
Compare: Risk Parity vs. Insured Allocation—both focus on risk management, but risk parity aims for balanced risk contribution across assets while insured allocation provides explicit downside protection. Risk parity accepts losses if they're proportional; insured allocation sets a hard floor.
These strategies customize allocation based on specific investor circumstances rather than applying universal rules. The principle is that different goals have different time horizons, risk tolerances, and funding requirements.
Compare: Goal-Based vs. Core-Satellite—goal-based allocation segments by objective while core-satellite segments by management style. A sophisticated investor might use both: goal-based buckets with core-satellite construction within each bucket.
These approaches combine elements from multiple allocation philosophies to create comprehensive frameworks.
Compare: Integrated vs. Dynamic—both involve ongoing adjustment, but integrated allocation incorporates strategic anchors and multiple decision factors, while dynamic allocation responds primarily to market conditions. Integrated is the "everything bagel" of allocation strategies.
| Concept | Best Examples |
|---|---|
| Passive/Fixed Targets | Strategic, Constant-Weighting, Age-Based |
| Active Adjustment | Tactical, Dynamic |
| Risk Management Focus | Risk Parity, Insured |
| Investor-Specific Customization | Goal-Based, Age-Based |
| Combines Active + Passive | Core-Satellite, Integrated |
| Requires Leverage | Risk Parity |
| Downside Protection | Insured, Goal-Based (for short-term buckets) |
| Lowest Management Complexity | Strategic, Constant-Weighting |
Which two strategies both maintain fixed allocation targets but differ in their rebalancing philosophy? What's the key distinction between them?
An investor believes markets are largely efficient but wants to occasionally exploit short-term mispricings. Which combination of strategies would best serve this philosophy?
Compare and contrast risk parity and traditional 60/40 allocation. Why might a 60/40 portfolio actually be less diversified from a risk perspective?
A 35-year-old investor has three goals: retirement in 30 years, a home down payment in 3 years, and a child's college fund in 15 years. Which allocation strategy is most appropriate, and how would the allocations differ across these goals?
If an FRQ asks you to recommend an allocation strategy for a risk-averse investor five years from retirement who wants growth potential but cannot afford significant losses, which strategy would you choose and why?