Are you looking for a way to boost your portfolio returns by taking advantage of short-term market opportunities? If so, you may be interested in tactical investing, an active investment strategy that involves adjusting your asset allocation based on current market conditions and trends.
In this article, we will explain what tactical investing is, how it works, what are its benefits and risks, and how you can implement it in your portfolio. We will also introduce you to Kubera, a wealth management and net worth tracking software that can help you manage your tactical investing strategy.
What is Tactical Investing or Tactical Asset Allocation (TAA)?
Tactical investing or tactical asset allocation (TAA) is a style of investing that involves actively managing a portfolio based on anticipated market trends or changes in outlook. The goal of tactical investing is to improve the risk-reward characteristics of the portfolio, boost overall returns, or preserve capital.
Tactical investing differs from strategic investing, which is based on longer-term asset allocation. Strategic investing involves setting a target asset allocation for your portfolio based on your financial goals, risk tolerance, and investment horizon, and rebalancing it periodically or when it drifts significantly from the target weights. Tactical investing involves varying the percentage invested in the market, shifting assets between sectors, or making trades based on short-term or medium-term opportunities .
Tactical investing requires taking on active risk, which is the risk of deviating from the strategic asset allocation. Active risk can be positive or negative, depending on whether the tactical allocation outperforms or underperforms the strategic allocation. Tactical investors are willing to take on active risk in exchange for the potential of higher returns.
How Does Tactical Investing Work?
Tactical investing works by adjusting the asset allocation of a portfolio across various asset classes, such as stocks, bonds, commodities, real estate, and cash, based on market signals and opportunities. Tactical investors use a combination of macroeconomic data, relative valuations, and technical indicators to identify market trends and anomalies across asset classes.
Tactical investors are not focused on selecting specific investments within each asset class, but rather on adjusting the overall exposure to each asset class based on their expected performance. For example, a tactical investor may increase their exposure to stocks when they expect strong economic growth and corporate earnings, or decrease their exposure to bonds when they expect rising interest rates and inflation.
One of the most common techniques used in tactical investing is managed-futures strategies. Managed-futures strategies are trend-following strategies that go long or short futures contracts across various asset classes (such as commodities, equity indexes, currencies, fixed income) based on market conditions. Managed-futures strategies aim to capture price trends and momentum in different markets and benefit from both rising and falling markets.
An example of how managed-futures strategies can be used in tactical investing is the recent dilemma faced by many investors regarding inflation. In April 2021, the U.S. consumer price index (CPI) rose by 4.2% year-over-year, the highest rate since 2008. Many investors were concerned about the impact of accelerating inflation on their portfolios, especially on their fixed-income investments. However, the Federal Reserve maintained its stance that inflation was “transitory” and that it would not raise interest rates or taper its bond-buying program anytime soon.
In this scenario, a tactical investor could use a managed-futures strategy to hedge against inflation risk by going long commodities futures contracts (such as gold, oil, copper) and short fixed-income futures contracts (such as Treasury bonds) . Alternatively, a tactical investor could also go long equity index futures contracts (such as S&P 500) and short currency futures contracts (such as U.S. dollar) if they believed that inflation would boost corporate earnings and weaken the dollar.
Three Benefits of Tactical Investing
Tactical investing may offer some benefits for investors who are looking for a way to enhance their portfolio returns by exploiting short-term market inefficiencies. Some of the potential benefits of tactical investing are:
- Opportunity to enhance portfolio returns by capturing excess returns or reducing risk relative to a strategic benchmark: By adjusting the asset allocation based on market signals and opportunities, tactical investors can potentially outperform a strategic benchmark or reduce their portfolio volatility. According to a study by Vanguard, tactical asset allocation can generate excess returns of 1.6% per year on average over a 10-year period.
- Improved diversification by adding uncorrelated investments like managed futures to a traditional 60/40 portfolio (60% stocks and 40% bonds): Managed futures have historically exhibited low or negative correlation with stocks and bonds, meaning that they tend to perform differently or even opposite to these asset classes . By adding managed futures to a portfolio, tactical investors can potentially improve diversification and reduce overall portfolio volatility. According to a study by Morningstar, adding managed futures to a 60/40 portfolio can lower the standard deviation by 2.3% and increase the Sharpe ratio by 0.2 over a 20-year period.
- Hedge against stock market risk by using managed futures: Managed futures have historically performed well during periods of stock market downturns or crises, such as the dot-com bubble burst in 2000-2002, the global financial crisis in 2008-2009, and the COVID-19 pandemic in 2020 . By hedging against stock market risk, managed futures can potentially enhance the risk-adjusted returns of a portfolio. According to a study by PIMCO, managed futures can provide positive returns during equity bear markets and reduce the maximum drawdown of a portfolio by 7.9% over a 30-year period.
Five Risks and Considerations of Tactical Investing
While tactical investing may offer some benefits, it also involves some risks and considerations that investors should be aware of before implementing it in their portfolios. Some of the main risks and considerations of tactical investing are:
- Active risk due to deviating from the strategic asset allocation: Tactical investing involves taking on active risk, which may result in higher volatility and lower returns than a strategic asset allocation. Tactical investing requires making frequent and timely adjustments to the asset allocation based on market conditions and opportunities, which may not always be accurate or profitable. Tactical investors may also incur higher transaction costs and taxes due to more frequent trading. According to a study by Vanguard, tactical asset allocation can increase the tracking error of a portfolio by 3.4% per year on average over a 10-year period.
- Higher fees for managed-futures strategies: Expense ratios for managed-futures strategies can be high, leading to higher fees for investors. According to Morningstar, the average expense ratio for managed-futures mutual funds was 1.87% as of March 2021, compared to 0.57% for U.S. equity mutual funds and 0.48% for U.S. bond mutual funds. Higher fees can erode the potential returns of tactical investing.
- Uncertain correlations between managed futures and stocks: “Uncorrelated” does not imply “negatively correlated,” so managed futures may not always mitigate stock downturns. While managed futures have historically performed well during periods of stock market crises, they may also perform poorly during periods of stock market rallies or sideways movements . For example, in 2017, the S&P 500 index gained 21.8%, while the Barclay CTA Index, a benchmark for managed-futures strategies, lost 2.3%. Moreover, the correlation between managed futures and stocks may change over time depending on market conditions and factors.
- Importance of risk tolerance and time horizon in tactical investing decisions: Tactical investing is suitable for investors who have a high risk tolerance and a short to medium-term investment horizon, as they can withstand higher volatility and take advantage of short-term market opportunities. However, tactical investing may not be suitable for investors who have a low risk tolerance and a long-term investment horizon, as they may prefer a more stable and consistent portfolio performance. According to Dave Chapman, head of multi-asset portfolio management for Chicago-based Legal & General Investment Management America, “For the vast majority of individuals, tactical asset allocation is fraught with risks including the risk of losing capital, exposure to higher volatility, regret and other behavioral factors that can compound these issues.”
- Past performance does not represent future results: Tactical investing relies on historical data and trends to make asset allocation decisions, which may not reflect future market conditions and opportunities. Tactical investors should be prepared for the possibility of underperformance or losses due to changing market dynamics or unforeseen events.
Four Tips to Implement Tactical Investing in Your Portfolio
If you are interested in tactical investing, here are some practical tips and guidance for implementing it in your portfolio:
Diversify and manage your portfolio risk
Tactical investing should not be seen as a substitute for diversification, but rather as a complement to it. Tactical investors should still maintain a diversified portfolio across different asset classes, sectors, regions, and styles, and adjust their asset allocation within a reasonable range based on their strategic benchmark. Tactical investors should also monitor and manage their portfolio risk by using appropriate tools and metrics, such as volatility, beta, Sharpe ratio, drawdowns, etc.
Consider your financial goals, risk tolerance, and investment horizon
Tactical investing is not a one-size-fits-all strategy; it depends on your personal circumstances and preferences. You should consider your financial goals (such as income generation, capital appreciation, wealth preservation), your risk tolerance (how much volatility and loss you can tolerate), and your investment horizon (how long you plan to invest) before deciding whether tactical investing is suitable for you. You can use tools such as risk tolerance questionnaires or asset allocation calculators to help you determine your optimal portfolio mix.
Seek professional advice if you are unsure or inexperienced with tactical investing
Tactical investing requires a high level of skill, knowledge, and discipline to execute successfully. If you are unsure or inexperienced with tactical investing, you may benefit from seeking professional advice from financial advisors and investment professionals who can help you design and implement a tactical investing strategy that suits your needs and goals. They can also help you monitor and adjust your portfolio performance based on changing market conditions and opportunities. You can find qualified advisors through platforms such as NAPFA or XY Planning Network.
Decide on a percentage of the portfolio that you will shift between different asset classes
There isn’t one specific way to make tactical shifts to a portfolio. In fact, it’s advisable to design your own strategy that suits your level of expertise, resources, and time constraints. The following guidelines are worth considering:
- Allocate a small portion of your portfolio (such as 10% to 20%) to tactical investing, while keeping the rest in line with your strategic asset allocation.
- Choose the asset classes that you will use for tactical investing, such as stocks, bonds, commodities, real estate, cash, etc. You can also use sub-asset classes, such as sectors, regions, styles, etc.
- Define the criteria that will trigger your tactical shifts, such as macroeconomic data, relative valuations, technical indicators, market sentiment, etc. You can also use tools such as ETF screeners or mutual fund screeners to help you identify the best performing or undervalued funds in each asset class.
- Set the frequency and duration of your tactical shifts, such as monthly, quarterly, or annually. You can also set a target return or a stop-loss for each tactical position to determine when to exit.
- Review and rebalance your portfolio regularly to ensure that it remains aligned with your goals and risk tolerance. You can also use tools such as portfolio trackers like Kubera to help you monitor and evaluate your portfolio performance.
How Kubera Can Help You with Tactical Investing?
If you are looking for a wealth management and net worth tracking software that can help you with tactical investing, you may want to check out Kubera. Kubera is a powerful platform that can help you consolidate your assets across different accounts and platforms (such as banks, brokerages, cryptocurrencies, real estate, etc.), monitor your portfolio performance and risk, and make informed tactical investing decisions.
Some of the features that Kubera offers to facilitate tactical investing are:
- A dashboard that shows your net worth, asset allocation, portfolio performance, and other metrics in one place.
- A portfolio rebalancing tool that helps you adjust your asset allocation based on your strategic benchmark and tactical opportunities.
- A beneficiary service that helps you protect your assets and legacy in case of your demise.
With Kubera, you can manage your tactical investing strategy with ease and confidence. You can also access Kubera from any device and any location, making it convenient and flexible for your busy lifestyle.
Tactical investing is a way of adjusting your portfolio based on short-term market opportunities. It can help you boost your returns, diversify your portfolio, and hedge against market risk. But it also comes with challenges, such as higher risk, fees, and skill requirements.
Tactical investing is not for everyone; it depends on your goals, risk tolerance, and time horizon. You should weigh the pros and cons carefully and seek professional advice if needed. You may also want to use a wealth management and net worth tracking software like Kubera to help you with your tactical investing strategy.
Kubera is a powerful and easy-to-use platform that lets you manage your assets across different accounts and platforms, track your portfolio performance and risk, and make smart tactical investing decisions. You can access Kubera from any device and any location, making it convenient and flexible for your busy lifestyle.