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9.5 Asset Allocation

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Series 65 Uniform Investment Adviser Law

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1 Introduction

About the Series 65 How to Use This Guide

2 Chapter 1: Economic Factors & Business Cycles

1.1 Business Cycles 1.2 Monetary Policy 1.3 Fiscal Policy 1.4 Inflation & Deflation 1.5 Interest Rates & Yield Curves 1.6 Global Economic Factors

3 Chapter 2: Financial Reporting & Analytical Methods

2.1 Financial Statements Overview 2.2 Accounting Fundamentals 2.3 SEC Filings & Annual Reports 2.4 Financial Ratios 2.5 Time Value of Money 2.6 IRR and NPV 2.7 Descriptive Statistics

4 Chapter 3: Types of Risk

3.1 Systematic (Market) Risk 3.2 Unsystematic (Company-Specific) Risk 3.3 Interest Rate & Reinvestment Risk 3.4 Inflation & Currency Risk 3.5 Liquidity Risk & Opportunity Cost 3.6 Risk Measurement & Portfolio Theory

5 Chapter 4: Cash Equivalents & Fixed Income Securities

4.1 Cash & Cash Equivalents 4.2 Treasury Securities 4.3 Agency Securities 4.4 Corporate Bonds 4.5 Municipal Bonds 4.6 Bond Pricing & Yields

6 Chapter 5: Equity Securities

5.1 Common Stock 5.2 Preferred Stock 5.3 Shareholder Rights & Corporate Actions 5.4 Equity Valuation Methods 5.5 ADRs, REITs & Other Equity Securities

7 Chapter 6: Pooled Investments

6.1 Mutual Funds 6.2 Mutual Fund Costs & Fees 6.3 Exchange-Traded Funds (ETFs) 6.4 Closed-End Funds & UITs 6.5 Hedge Funds & Private Equity

8 Chapter 7: Derivatives, Alternative Investments & Insurance Products

7.1 Options Basics 7.2 Options Strategies 7.3 Alternative Investments 7.4 Annuities 7.5 Life Insurance Products

9 Chapter 8: Client Types & Profiles

8.1 Individual Clients 8.2 Business Entity Clients 8.3 Trusts & Estates 8.4 Accredited & Qualified Investors 8.5 Suitability & Know Your Customer

10 Chapter 9: Portfolio Theory & Capital Markets

9.1 Modern Portfolio Theory 9.2 Capital Asset Pricing Model (CAPM) 9.3 Efficient Market Hypothesis 9.4 Risk & Performance Measures 9.5 Asset Allocation

11 Chapter 10: Portfolio Management Strategies

10.1 Investment Styles 10.2 Portfolio Management Techniques 10.3 Fixed Income Strategies 10.4 Return Calculations

12 Chapter 11: Tax Considerations & Retirement Planning

11.1 Capital Gains & Investment Taxes 11.2 Retirement Plans Overview 11.3 Individual Retirement Accounts (IRAs) 11.4 Education Savings Plans 11.5 Distributions & RMDs

13 Chapter 12: ERISA, Special Accounts & Performance Measures

12.1 ERISA Requirements 12.2 Special Account Types 12.3 Performance Measures & Reporting 12.4 QDROs & Special Situations

14 Chapter 13: Regulation of Investment Advisers

13.1 Investment Advisers Act of 1940 13.2 Registration Requirements 13.3 Recordkeeping Requirements 13.4 Custody Requirements 13.5 Exempt Reporting Advisers

15 Chapter 14: Regulation of Investment Adviser Representatives

14.1 IAR Definition & Requirements 14.2 Registration & Post-Registration 14.3 IARs of Federal Covered Advisers

16 Chapter 15: Regulation of Broker-Dealers & Agents

15.1 Broker-Dealer Definition 15.2 Agent Registration 15.3 Regulation Best Interest

17 Chapter 16: Securities Registration & Exemptions

16.1 Uniform Securities Act 16.2 Securities Registration Methods 16.3 Exempt Securities 16.4 Exempt Transactions

18 Chapter 17: Communications & Client Relationships

17.1 Advertising Rules 17.2 Social Media & Electronic Communications 17.3 Client Agreements & Disclosure 17.4 Proxy Voting & Other Obligations

19 Chapter 18: Ethics & Fiduciary Obligations

18.1 Fiduciary Duties 18.2 Prohibited Practices 18.3 Senior & Vulnerable Adult Protection 18.4 AML & Compliance Programs

9.5 Asset Allocation

Key Takeaways Explain This Topic AI

Asset allocation drives most portfolio return variability.

Strategic allocation is a long-term policy based on client profile.

Tactical allocation is short-term deviations from strategic targets.

Rebalancing maintains targets and controls risk.

Rebalancing tends to buy low and sell high.

Consider taxes and transaction costs before rebalancing.

Last updated: December 2025

Asset allocation—dividing investments among different asset classes—is widely considered the most important investment decision. Research suggests it accounts for the majority of portfolio return variability.

Why Asset Allocation Matters

A landmark study by Brinson, Hood, and Beebower found that approximately 90% of portfolio return variability is explained by asset allocation policy, not security selection or market timing.

  • Factor Contribution to Return Variability
  • Asset Allocation Policy ~90%
  • Security Selection ~5%
  • Market Timing ~2%
  • Other Factors ~3%
  • Major Asset Classes
  • Traditional Asset Classes
  • Asset Class Characteristics Role in Portfolio
  • Equities (Stocks) Higher return potential, higher risk Growth
  • Fixed Income (Bonds) Lower return, lower risk, income Stability, income
  • Cash/Money Market Lowest return, highest liquidity Safety, liquidity
  • Alternative Asset Classes
  • Asset Class Characteristics Correlation to Stocks
  • Real Estate (REITs) Income + growth, inflation hedge Moderate
  • Commodities Inflation hedge, uncorrelated Low to moderate
  • Private Equity High return potential, illiquid Varies
  • Hedge Funds Absolute return strategies Low (if managed well)
  • Sub-Asset Classes
  • Category Sub-Classes
  • Equities Large cap, mid cap, small cap; growth vs. value; domestic vs. international; developed vs. emerging

Fixed Income Government, corporate, municipal; investment grade vs. high yield; short, intermediate, long duration

  • Types of Asset Allocation
  • Strategic Asset Allocation (SAA)

Definition : Long-term, policy-based allocation based on client profile and goals.

  • Feature Description
  • Time Horizon Long-term (years)
  • Approach "Buy and hold" with periodic rebalancing
  • Based On Client risk tolerance, time horizon, goals
  • Changes Only when client circumstances change
  • Goal Match allocation to client's investment policy

Example : A moderate investor might have a strategic allocation of:

  • 60% Stocks
  • 35% Bonds
  • 5% Cash
  • Tactical Asset Allocation (TAA)

Definition : Short-term deviations from strategic targets based on market conditions.

  • Feature Description
  • Time Horizon Short-term (months)
  • Approach Active adjustments based on market views
  • Based On Market valuations, economic outlook
  • Changes Frequent, within defined ranges
  • Goal Add value through market timing

Example : If the market appears overvalued, a tactical manager might temporarily shift from the strategic 60% equity to 50% equity.

Comparing SAA and TAA

  • Feature Strategic Tactical
  • Philosophy Markets are efficient Markets can be timed
  • Trading Minimal (rebalancing only) More frequent
  • Costs Lower Higher
  • Skill Required Lower Requires forecasting ability
  • Evidence Generally supported Mixed results
  • Dynamic Asset Allocation

Definition : Continuous adjustments based on market conditions, often contrarian.

  • Feature Description
  • Approach Systematically adjust allocation as markets move
  • Example Rule Reduce equity exposure as market rises
  • Nature Often contrarian (buy low, sell high)
  • Implementation Can be formula-based
  • Constant-Proportion Portfolio Insurance (CPPI)

Definition : Formula-based strategy that maintains a floor value while adjusting equity exposure.

  • Market Condition Action
  • Portfolio rises Increase equity exposure
  • Portfolio falls Decrease equity exposure

Goal : Protect against downside while participating in upside.

  • Rebalancing
  • Purpose of Rebalancing

Rebalancing returns a portfolio to its target allocation after market movements cause drift.

  • Benefit Description
  • Risk Control Prevents portfolio from becoming too aggressive or conservative
  • Discipline Systematically "buy low, sell high"
  • Alignment Keeps portfolio consistent with investment policy
  • Rebalancing Approaches
  • Approach Description Pros Cons
  • Calendar Rebalance at fixed intervals (quarterly, annually) Simple, predictable May not capture large drifts
  • Percentage Rebalance when allocation drifts by X% (e.g., 5%) Responsive to market Requires monitoring
  • Combination Both calendar and percentage triggers Balanced approach More complex

Example : If target is 60% stocks and actual allocation drifts to 70% stocks after a rally, rebalancing would sell stocks (high) and buy bonds (relatively low).

Rebalancing Considerations

  • Factor Consideration
  • Transaction Costs Frequent rebalancing incurs trading costs
  • Tax Impact Selling winners may trigger capital gains
  • Account Type Tax-deferred accounts avoid tax impact
  • Timing More frequent isn't always better
  • Asset Allocation Process
  • Steps for Advisers
  • Gather client information (risk tolerance, time horizon, goals)
  • Determine strategic allocation based on client profile
  • Select specific investments within each asset class
  • Implement the portfolio
  • Monitor and rebalance as needed
  • Review periodically and adjust for life changes
  • In Practice

Common allocation guidelines (rules of thumb, not absolute rules):

  • Client Type Stocks Bonds Cash
  • Aggressive 80-100% 0-20% 0-5%
  • Moderate Growth 60-80% 20-35% 0-5%
  • Moderate 40-60% 35-55% 5-10%
  • Conservative 20-40% 50-70% 10-20%
  • On the Exam

Series 65 frequently tests:

  • Distinguishing strategic (long-term) from tactical (short-term) allocation
  • Understanding the purpose of rebalancing
  • Knowing asset allocation is the primary driver of returns
  • Recognizing that rebalancing systematically "buys low, sells high"
  • Key Takeaways
  • Asset allocation accounts for ~90% of portfolio return variability
  • Strategic allocation is long-term, based on client profile
  • Tactical allocation involves short-term deviations based on market views
  • Rebalancing maintains target allocation and controls risk
  • Rebalancing systematically "buys low, sells high"
  • Consider transaction costs and taxes when rebalancing

Moderate Allocation Example