Portfolio construction and asset allocation
Building the allocation
Strategic asset allocation (SAA) sets long-run weights to asset classes and explains most of a portfolio's return variability over time. Tactical asset allocation (TAA) tilts away from SAA within written limits. Diversification works across asset classes, issuers, sectors and currencies, and its benefit depends on correlation rather than on the number of holdings. Constraints to respect are each goal's horizon, liquidity, tax treatment (PIE rates, FIF), the currency hedging policy, and the client's stated preferences.
Rebalancing discipline
Set bands in advance, for example plus or minus five percentage points around target, or rebalance using contributions and withdrawals to limit transaction costs and taxable events. Rebalancing is risk control, not a return forecast.
Worked example
Target 60/40 on a $200,000 portfolio means equities $120,000 and bonds $80,000. A strong equity year lifts equities to $140,000 while the total stays near $200,000, so the mix is 70/30. Target equity is still $120,000, so sell $20,000 of equities and buy bonds. If the client contributes $2,000 a month, direct the next ten months into bonds instead and avoid the sale entirely: same risk reduction, lower cost.
Traps
- Rebalancing monthly, adding cost for negligible risk benefit.
- Ignoring tax and FIF consequences of selling in order to rebalance.
- Chasing last year's best-performing asset class into a higher weight.
- Applying an age-based rule while ignoring the client's actual spending needs and goal dates.