In strategic asset allocation, long-term capital expectations are integrated with a client's goals and a target allocation is established. With tactical asset allocation, adjustments are made based on short-term expectations for an asset class.
I use a combination of strategic and tactical approaches, though the tactical portion is much smaller. Here's an example of how I employ the tactical approach. In early 2008, I expected the U.S. dollar to weaken so I bought a currency ETF which pits the dollar against the euro. I also bought an ETF investing in oil when it was at $107 a barrel. In July 2008 I closed out both at a profit (at the time oil was at $138 a barrel). While I would probably never fully exit the market, I did reduce the stock exposure for clients to a maximum of 35% and raised cash. All of this helped minimize losses for my clients last year.
Mutual Funds and ETFs
I use mutual funds, ETFs, and individual bonds. In my opinion, mutual funds are the most appropriate for subcategories which are less volatile and for those you expect to hold for a longer period of time. I use ETFs when I want to be more tactical or need the ability to get in and out quickly if necessary. I prefer to buy individual bonds if the bond portion of the portfolio is large enough to buy several issues with various maturities. I would not buy small amounts of individual bonds as they are more difficult to sell at a firm price if you should decide to get out prior to maturity.
Here's an example of how I use mutual funds and ETFs. Let's assume I want to invest 15% of a client's portfolio in large-cap value stocks. I might use a mutual fund for half and an ETF for the other half. Then, if I wake up one morning and hear that the sky is falling in the stock market (as it did last year) I can reduce my stock exposure by exiting the ETF first thing in the morning. With a mutual fund, I'd have to wait until the close of the market that day.