We are going to examine 3 investment management value strategies to adjust and optimize your asset allocation. Value strategies involve finding investment assets that can be bought at a price low enough to provide a margin of safety. The focus of value investing is: price matters.
An asset allocation plan should consider valuation by comparing the price to the fundamental or intrinsic value. Studies show that owning assets when prices are bargains produces above average rates of return, but owning assets when prices are expensive produces lower than average rates of return.
Academic studies have demonstrated that asset allocation will determine 90% of your portfolio returns. Here are 3 practical value investment management strategies to optimize your asset allocation:
1. Portfolio Rebalancing
2. Tactical Asset Allocation
3. Develop Investment Rules and Strategies
Portfolio rebalancing is a risk management strategy in which you buy or sell investments to achieve a desired asset allocation percentage. As asset prices move up or down the total value will depart from the desired asset allocation target.
Portfolio rebalancing causes an investor to buy low and sell high. This is because rebalancing involves selling a portion of the assets that have risen in price and buying more of the assets that have fallen in price in order to get back to your target asset allocation.
Tactical Asset Allocation Strategy
Instead of having a fixed asset allocation target, the value investor should adapt to changing valuations. A tactical asset allocation strategy provides the flexibility to take advantage of price volatility.
Why would an investor want to own the same amount of an asset when it is expensive as he would when it is a bargain? Assets that become undervalued can have their asset allocation target increased. Assets that are overvalued can have their asset allocation target decreased or eliminated. This is another approach to forcing yourself to buy low and sell high.
Develop Investment Rules and Strategies
I have developed 32 Investment Rules and Strategies that I review and attempt to adhere to on an ongoing basis. You may want to review these and contemplate how they can improve your investment skills. Whether you embrace mine, or make your own, you should have an investment template.
Investment Management Value Strategies Put Together
The benefits of putting these 3 value investment management strategies together can be enormous. First, having a set of rules and strategies down in writing gives you a strong foundation. This improves your chances of avoiding catastrophic mistakes.
If a change in asset categories, sectors, or individual stock prices moves the value from your target asset allocation it’s time to rebalance. Each investor can decide at what point they want to rebalance. I prefer frequent rebalancing.
When I rebalance I also consider whether I want to change my asset allocation target. If an asset has risen in price, but so have the fundamentals such as earnings and dividends, I might just sell a little to rebalance to my original target asset allocation. But if the price has increased more than the fundamentals, making the valuation expensive, I might choose to lower my target asset allocation.
If the price of an asset has fallen farther below its fundamental or intrinsic value I might increase my target asset allocation, and rebalance to a higher target. But if the fundamental value is deteriorating then I may need to lower my target allocation or sell the entire position.
All together, these 3 investment management strategies can be used to optimize your asset allocation. A set of investment rules and strategies, rebalancing your portfolio, and implementing a tactical asset allocation will lower portfolio volatility and improve long term returns.
What strategies do you use when adjusting your asset allocation?