Monday, November 5, 2012

Is Tactical Practical?

There was an interesting article in the Wall Street Journal this weekend questioning whether tactical asset allocation has merit anymore (after a ton of articles following 2008 questioning buy and hold).  The author points out that a buy and hold portfolio of 60% stocks and 40% bonds would have outperformed tactically managed portfolios over the past three years so maybe tactical isn't practical.  

We have talked about this in other posts but to reiterate, you have markets that are in an uptrend, markets that are in a downtrend, and markets that are choppy.  Buy and hold rides the market up and rides the market down.  Tactical asset allocation stays in harmony with market trends.  When stocks are going up it will invest in them, when they start to go down it will get out of them and into cash or whatever else is going up.  In an uptrend a tactical portfolio and a buy and hold portfolio will look pretty similar.  In a downtrend, the buy and hold portfolio will ride the market down while tactical will not.  Choppy markets are the worst kind of markets for tactical as there are no real trends to grab onto.  The end result could be an up market, like this year and 2010, or a basically flat year like 2011.  Buy and hold portfolios ride the market up and down and end up wherever the market ends up.  This is of course assuming the investor can stand the volatility---a buy and hold investor in the S&P 500 would have had to hold on through the following:

May 2010 down 7.99%
June 2010 down 5.23%
August 2011 down 5.43%
September 2011 down 7.03%
May 2012 down 6.01%

Source: Morningstar

Because tactical asset allocation does not try to predict markets (nobody can do that), choppy markets with large up months and large down months are very difficult to navigate as there is no real trend to grab onto.  So is tactical practical?  If every year going forward the market was going to be choppy and we would never have another 1973-4, 2000-2, or 2008 again then maybe not.  Of course that is not how markets work, we will always have up markets, down markets, and choppy markets.  A buy and hold portfolio may make money in up and choppy markets but it will give it back in the down markets.  Tactical will not beat buy and hold every week, month, year, or three years.  But, over time, a good tactically managed portfolio will always blow away a buy and hold portfolio because it will hang onto most, if not all, gains during a down market.

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