Understanding – and correctly applying – the difference between strategy and tactics is one of the fundamental factors of investment success.
Investment Strategy
Investment strategy is the overall approach that an investor takes to achieve their financial goals. It is a long-term plan that takes into account an investor’s risk tolerance, time horizon, and financial goals.
VS
Investment Tactics
Investment tactics, on the other hand, are the specific steps that an investor takes to implement their investment strategy. They are the short-term decisions that an investor makes, such as which specific stocks or bonds to buy or sell.
With strategy, you are the centre.
Investment strategy determines the mix of assets, by asset class NOT the individual securities themselves. Here, we are fundamentally concerned with why and who questions from a personal perspective.
Why is the portfolio being created?
- Is it saving for retirement?
- Creating a bit of a nest egg for the future?
- A way to generate additional income?
Who is it being created for?
- When do you want your money back? Is it a defined deadline or more flexible timelines?
- What are your tax circumstances?
- How quickly do you need to be able to turn the portfolio into cash?
Strategy sets the direction of travel and ensures that your asset class allocation is aligned with the goals of the portfolio.
Tactics focus on the investing outlook.
Tactics are the implementation of the strategy and therefore function at the level of the individual securities.
At this level, the investor is trying to ascertain whether the investing environment for the asset in question is likely to be positive or negative and why.
This involves questions like:
- What are the opportunities driving the success of this asset?
- Why this specific asset? What’s the competitive advantage? Is this advantage likely to persist for my holding period?
- What are the risks to success and how likely are they to impact performance?
Your tactics will depend on your outlook on where you see opportunities and risks within the environment.
Here’s a little simplified illustration about how strategy and tactics can feed ino your portfolio construction.
The Impact
A study by Vanguard[1] found that individual security selection, which is the key function of investment tactics, accounts for less than 10% of the variation in portfolio returns over time, compared with just buying and holding. This means that choosing the right mix of assets, such as the ratio of stocks and bonds, is more important than selecting individual securities.
Tactical outperformance is based on superior market timing.
To outperform the wider market using tactics, the investor has to be right 5 different ways consistently:
- Identify reliable predictors of future economic surprises.
- Time the exit down to the precise day.
- Time the re-entry down to the precise day.
- Have excellent funding terms and position management strategy.
- Have transaction costs for both entry and exit that are lower than the associated benefit of each trade.
This can be rather difficult to do. In fact, an investor would need to predict major economic surprises at least 75% of the time in order to outperform the market over the long term.
The Growth of $1000 Invested Based on how Successful Investors were at Anticipating Economic Surprises
Being right that often is something only the top 5% of tactical managers can do over a 5-year and even those get nudged out by the best strategic allocation managers by the 10-year mark.
The fundamental reason for the difficulty in trying to time the market is a concept called market efficiency. This concept effectively means that all of the outstanding information is quantified and integrated into the price of the asset.
Therefore, the price you pay today is, generally, reflective of the true value of the asset.
Trying to buy and sell market fluctuations is saying that you are betting your transaction fees and opportunity costs that you are smarter than the thousands of incredibly smart and hard-working professionals.
The research clearly shows this is not usually the case.
The fact is that most investors get too caught up in the tactical aspect of investing. This is the dynamic area, where daily news events and fads are constantly tempting you to overcomplicate your investing strategy.
Tinkering too much with your tactics often outweighs the benefit of having a clear strategy.
Focus on where the returns are generated – your investment strategy -, simplify your investment tactics.