Diving Deeper into Portfolio Management

January 18, 2022

The heart of every investment strategy is your portfolio. It’s where the rubber hits the road—or rather, where your strategies meet your assets and hopefully produce good results.

And these days, you don’t need a professional financial advisor to manage your portfolio. These days, average investors can access great solutions without having to swallow hefty advising fees.

Of course, if you’re new to it, portfolio management can feel quite daunting. Here’s a breakdown of the basics to help new investors get started.

What is a Portfolio?

Your investment portfolio is a set of financial assets including things like:

  • Stocks
  • Bonds
  • Cash
  • Currencies
  • Commodities

Yet your investment portfolio is also a group of assets that you use to generate profit while preserving capital. Keep in mind that your portfolio is more of a concept—investments usually aren’t housed in a single account.

Every investor’s portfolio is unique. It depends on a number of factors, such as their age, investment goals for the portfolio, and their risk tolerance, just to name a few. Either way, the assets inside the portfolio are divided into asset classes, a group of investments sharing similar characteristics and are subject to the same laws and regulations. A portfolio should contain a well-balanced mix of assets based on the investor’s goals and risk tolerance.

What is Portfolio Management?

Portfolio management is the art and science of overseeing a group of assets to achieve the investor’s long-term financial goals, based on the investor’s timeline and risk tolerance. This requires more than just assessing individual investments—you have to be able to assess strengths, weaknesses, opportunities, and threats across the portfolio as a collective unit.

Regardless of the basket, the goal is the same: to maximize returns within an appropriate level of risk exposure.

Because no investment is guaranteed, this requires a careful assessment of the available information. A smart portfolio manager knows how to read value signals or red flags on any new investment and can understand how the investment fits into the larger portfolio.

In addition, a portfolio manager must go into the process understanding that investment is the art of trade-offs. No investment is perfect, and you can’t be everywhere at once. Because of that, you have to make strategic decisions based on what’s important to you.

There are two types of portfolio management: active and passive.

Active Portfolio Management

Picture a Wall Street investor in a suit, showing up to work each day to make trades and manage a client’s money day in and day out. They’re the definition of hands-on. You’re thinking of a textbook case of active portfolio management.

Active management is when an investor or investment professional relies on research, forecasts, and personal judgment to track a portfolio’s performance and attempt to outperform the market in comparison to a benchmark or a market index, such as the S&P 500 Index.

Historically, investors have relied on professional portfolio managers for active investment strategies. However, these options were usually open only to the wealthy, since high portfolio management fees cut into your total performance gains. These days, it’s now possible to actively manage your portfolio yourself, though it reduces your access to certain investments that you might get through a brokerage firm.

Passive Portfolio Management

Passive portfolio management is typically used in reference to exchange-traded funds or mutual funds, where the portfolio’s performance mirrors the performance of a selected market index as closely as possible. This is the set-it-and-forget-it strategy.

Because this option doesn’t come with high management fees associated with active management strategies, it’s widely popular among average investors. Robo-advisors, computer platforms providing automated algorithmic investment based on the user’s parameters, are a textbook example of this strategy at work.

Which is Right for You?

The choice of management strategies depends on your knowledge, your investment style, and what you hope to achieve.

If you’re new to investing and don’t have the time or wherewithal to choose investments for yourself, passive strategies are a good idea. They allow you to attain broad diversification without the need to select assets yourself. Plus, algorithms eliminate the risk of emotional investing.

On the other hand, if you’re well-versed in investing and want to branch off the beaten path, an active strategy may be a better choice. This allows you to take control of your assets (or access some less common investments through a financial manager) in order to achieve better growth.

It’s also important to remember that passive investing is generally considered less risky than active investing. For investors who are risk-averse, passive investing (especially through a robo-advisor) is often a better choice.

Elements of Portfolio Management

Regardless of which style you choose, there are three key concepts to be aware of in portfolio management:

  1. Asset allocation
  2. Diversification
  3. Rebalancing

Asset allocation is an investment strategy that constructs a portfolio of various investments to balance risk and reward based on the investor’s goals. You’ll often see asset allocation expressed as percentages of various assets in your portfolio.

Asset allocation goes hand-in-hand with diversification, which is a strategy that manages risk by spreading your investment dollars across various asset classes (preferably those with limited correlation) so that if one asset class takes a hit, you won’t lose your entire portfolio.

However, even if you use passive investment strategies, you still need annual rebalancing, which is the process of realigning asset weightings to account for market changes and your risk appetite. Robo-advisors automatically rebalance your portfolio for you, but if you manage your portfolio actively, you’ll have to do it yourself.

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