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Tactical Versus Strategic Investing

I got an inquiry about my last three blog posts, the three important investment concepts, suggesting that these are market timing techniques. I disagree with this characterization. These 3 investing concepts are just important things to keep in mind while you are investing. But it is possible these investing concepts may cause you to do what I call tactical investing. In this post I thought it might be helpful to clarify the difference between tactical investing and strategic investing.

Most of the investing posts I have written in this blog I would call “strategic” investing techniques. Strategic techniques are investing concepts you should practice most of your investing life. Selecting a proper equity allocation, developing a diversified portfolio, periodic re-balancing of your portfolio, monthly dollar cost averaging are examples of long term strategic investing techniques. “Tactical” investing is not market timing. It is the process of making small changes at the margins of your portfolio to slightly change your portfolio’s emphasis as the markets change.

The underlying theme behind the three important investment concepts, Part I, Part II, and Part III I discussed in my previous posts are to be aware of the overall market environment when periodically reviewing your investments. This awareness may cause you to occasionally make some tactical changes to your investments. It is not necessary, though, to do any tactical investing if you desire to be a totally passive investor.

However, during the past 10+ year bear market some market sectors have experienced extreme conditions, the most notable ones being the late 1990s technology bubble and the mid-2000s real estate bubble. Some tactical investing moves at your portfolio margins can enhance your returns. And when in a long term bear market, enhancing your returns anyway you can is important. Tactical investing does take a little more time as it requires you to pay attention to the different moving parts in the markets (All the investment newsletters I subscribe to undoubtedly assist me in following the different market sectors). But it is important to remember that tactical investing should not change your basic strategic investing principles you have adopted.

Let me provide a couple of examples of how I have integrated tactical investing into my overall investing strategy in the past. In my recent post recommending you to “Do the opposite of what everyone else does,” I mentioned how petroleum companies and Real Estate Investment Trusts (REITs) were out of favor in 1999-2000 and were obviously undervalued. In investing in these two undervalued sectors, I did not abandon my 60% target equity allocation I was maintaining at the time nor did I sell my other equity allocations (e.g., small cap stocks or international stocks).

At the time two-thirds of my 60% equity allocation was dedicated to large cap stocks (i.e., about 40% of my overall portfolio). The tactical move I made was to reduce my 40% large cap stock fund to 30% and I bought large integrated oil companies and blue chip REITs with the other 10%. This move adjusted the focus of my large cap stock allocation somewhat, but it was not a wholesale change in strategy. In other words, I did not abandon my strategic investing approach and invest all my funds in these undervalued sectors. To do so would truly be trying to time the market.

In my current portfolio I have made a few tactical changes with the goal of reducing my overall portfolio risk because, I feel, at this time (summer 2011) the world markets are fraught with peril. However, if I sold all my equities and moved all my assets to fixed income, I would be acting like a market timer. You should never be completely out of the stock market because you never know what the market is going to do next. I feel the market is risky right now, but who knows, it could increase another 20% from here. If, at any time, you are really feeling uncomfortable about the stock market, you should dial back your equity allocation percentage, but not to zero percent.

Anyway back to my current tactical moves. I actually have made three different moves to reduce portfolio risk.

1. In my opinion, in 2011, the big banks of Europe and the US are still in a precarious position. The balance sheet problems the big banks had in 2008 still exist. So one of the tactical investing moves I made this past spring was to sell all individual financial sector stocks. I also sold my large cap mutual fund because 28% of its holdings consisted of large financial institutions (any fund prospectus will outline what sectors the fund’s holdings are invested in). I simply replaced my large cap mutual fund with another large cap fund that only has about 6% of their holdings in the financial sector.  I want as little exposure to the large western banks as possible.
2. The second tactical change I made was I adjusted my individual stock portfolio to weight it more heavily towards the more defensive sectors; utility, health care, and consumer staple companies, which traditionally hold up better when the market goes through a correction.
3. Finally, it is my opinion that, at some point, interest rates are going to rise so I have sold any funds that had any intermediate or long term bonds and moved all these assets to short-term bond funds that will benefit from rising interest rates.

These recent tactical moves are the most impactful I have made to my portfolio in many years. However, it should be noted I have not changed my target allocation of 40% equities and 60% fixed income; I have only adjusted the composition of my equity and income allocations.

I also want to point out that these recent specific portfolio moves I made are based on the needs of my portfolio and my opinion of the current markets. I have presented them here to illustrate how tactical investing can be integrated into one’s portfolio without changing the overall strategy of the portfolio. These are not necessarily the right tactical moves for other people.

To summarize:

• You should never abandon your strategic investing principles,
• It is not necessary to do any tactical investing if you desire to be a totally passive investor,
• If you do any tactical investing, it should be only at the margins, and it should not radically change your portfolio.

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