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When it comes to the basic rules on how to create a portfolio for an investor, the strategic (long-term) asset allocation (SAA) is the most important part. This is because the SAA determines the risk/return profile of the portfolio over the long run and needs, therefore, to be aligned with the risk-bearing capacity of the investor. (Please see the article: “What is investment risk” for more details on this topic)

Since this alignment is superordinated to the whole portfolio construction and monitoring process, the evaluation of the risk-bearing capacity is the first step when tailoring a portfolio for a specific investor.

The derived strategic asset allocation (for example 60% equities and 40% bonds) is the average target portfolio and not a static value. How large the deviations might be is once again determined by the risk-bearing capacity of the investor.

These deviations might either be caused by market movements or by tactical asset allocation (TAA) decisions. While deviations caused by market movements will be eliminated during the next rebalancing process, TAA driven deviations may stay in the portfolio as long as the respective investment case is in place. That said, the tactical asset allocation should normally only lead to short term deviations from the SAA, as these decisions often depend on current market trends.

The topics rebalancing and tactical asset allocation (TAA) will be further explained in separate articles.

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