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Is it time to be tactical?

By Sheyna Steiner · Bankrate.com
Friday, October 26, 2012
Posted: 1 pm ET

At any given point in time, it's not difficult to find someone predicting the end of the world -- particularly if they're predicting dire economic circumstances.

Given all the economic headwinds facing the economy at the moment -- the election, the so-called fiscal cliff at the end of the year, and the debt and banking crisis in Europe -- it's pretty common to hear people forecasting a market downturn sometime in the near future.

What should you do if you hear that?

Just like opinions about the future, there are lots of opinions on how you should invest and what to do if you sense a shift in the wind. Here's one option for when the water-cooler chitchat turns to coming market volatility: do nothing.

Doing nothing, or more accurately, sticking with your investment plan, is in opposition to the idea of tactical asset allocation. Asset allocation is the strategic portioning of your portfolio into various asset classes to achieve diversification and the level of risk you desire.

Tactical asset allocation is looking into the future and moving into or out of investments based on what you think is going to happen. For instance, if an investor believes that some kind of calamity will befall the planet at the end of the year and suspects that it might impact the stock market, they might scale back on aggressive equity investments and move toward investments that do well in economic contractions, such as utilities or tobacco stocks. They may move more money to cash or bonds as well.

Two questions: Will that help you avoid market volatility, and will it lead to increased returns over time?

Maybe, particularly if you're good at predicting what will happen and when. It should go without saying, but I'll say it anyway: Most people are not.

"Tactical asset allocation is an investment strategy that surges in popularity from time to time, especially after bear markets. It's nothing more than a fancy name for market timing and a way to charge higher fees," says Larry Swedroe, principal and the director of research for the Buckingham Family of Financial Services and author of the recent book, "Investment Mistakes Even Smart Investors Make and How to Avoid Them."

Everyone would like to avoid market downturns, but no one has mastered the art of predicting when they will happen.

"All the studies show that there aren't people who can forecast the economy -- even the people who can influence the economy, economists at the Federal Reserve and in the Treasury Department, their forecasts have been no better than the proverbial chimps throwing darts," Swedroe says.

Hence the reason that most actively managed mutual funds fail to outperform their benchmarks.

"The key to successful investing (is) have a plan, stick to it, keep costs low and tax-efficiency high. Use index or other funds like that and -- it’s the only guarantee in investing -- you will outperform the vast majority of investors -- individual and institutional," says Swedroe.

Experts typically recommend re-balancing your portfolio at regular intervals or after major rallies. That means selling funds that have overgrown their allocations and buying more of the asset classes that are struggling in order to get back to your planned asset allocation.

Staying within your risk tolerance and re-balancing regularly should position investors to ride out nearly any market.

What do you think?

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