An investment adviser is performing a portfolio review for a client who is nearing retirement. The client's portfolio is currently heavily invested in growth stocks. The adviser recommends shifting a portion of the portfolio into income-generating assets like high-quality bonds and dividend-paying stocks. This strategy is an example of:
- ATactical asset allocation
- BRebalancing
- CMarket timing
- DStrategic asset allocation
Show answer & explanationAnswer & explanation
Correct answer: D. Strategic asset allocation
Strategic asset allocation involves setting long-term target allocations for various asset classes based on an investor's goals, risk tolerance, and time horizon. As a client nears retirement, their risk tolerance typically decreases, and their need for income increases, necessitating a shift from growth-oriented assets to more conservative, income-generating ones. This is a long-term, goal-driven adjustment to the core asset mix.
Why the other options are wrong
- A. Tactical asset allocation involves short-term deviations from strategic allocation to capitalize on perceived market opportunities, distinct from a long-term shift due to life stage.
- B. Rebalancing involves restoring a portfolio to its original target asset allocation, not fundamentally changing the target allocation itself due to a life event.
- C. Market timing involves frequent buying and selling based on short-term market predictions, which is not what's described here.
Strategic Asset Allocation
A long-term investment strategy that involves setting target allocations for various asset classes based on an investor's risk tolerance, investment horizon, and financial goals.
- Focuses on maintaining a diversified portfolio over the long term.
- Allocations are adjusted periodically in response to significant life changes or goal shifts.
- Contrasts with tactical asset allocation, which involves short-term deviations.
Memory trick: Allocation has 'STRATEGY': Set targets, Time horizon, Risk profile, Adjust goals.