My pet theory about TAA

I was recently sucked into the world of day trading. I had a few hours to kill at home, so it was a case of either checking on some investments or playing with the cat. As fate would have it, the cat had other plans.

Like so many activities that can be enjoyed on a smartphone, buying and selling stocks while sprawled on a couch proved strangely addictive. I soon realized I was in danger of vanishing down a rabbit hole, at which point I withdrew.

As I wrote a couple of years ago, a financial outlook principally measured in days or less may not qualify as investing per se. It is more akin to gambling. This might be why I gradually came to feel the cat could match or even surpass my trading performance if I left the phone in his paws for a while – although you may be relieved to learn I did not actually put this idea to the test.

In my opinion, genuine investing demands a long-term view. It requires us to understand the enduring impacts of megatrends, themes, demographics and other factors likely to shape lasting transformation. Broadly speaking, it is the stuff of strategic asset allocation (SAA).

So where does this leave tactical asset allocation (TAA)? If we imagine a spectrum running from “gambling” to “investing”, with day trading at one end and SAA at the other, TAA would most likely fall somewhere to the right of a midpoint marked “speculation”.

TAA tends to be momentum-driven. If markets become more volatile, for example, it takes the form of a shift to less risky assets. Such fine-tuning can be useful in managing, say, a pension fund’s balanced portfolio or an insurer’s assets and liabilities.  

The reality for many investors, though, is that TAA need not be a major consideration. An SAA framework grounded in solid capital market assumptions, perhaps with some exposure to alternatives for diversification purposes, can be the most effective approach for those with long-term horizons.

Sovereign investors may offer the ultimate illustration. They very rarely – if ever – let short-term developments undermine their rationales, risk tolerances and goals. They value patience. They exemplify the adage, as illustrated by the chart below, that time in the markets beats timing the markets.

Feel free to take comfort from the well-intentioned tinkering that TAA entails. All those short-term tweaks may well help you. But always remember that true investment success most often comes to those who rise above the noise, stick to their underlying principles and stay the course.

US stock market annualized returns – 1928-2021

Source: Vanguard, Macrobond; as of 31 December 2021

Note: returns based on daily price return of S&P 90 from January 1928 to March 1957 and S&P 500 thereafter, as a proxy for the US stock market; reinvested dividends not included