Developing a healthy investing portfolio is a step-by-step procedure. The key of building a lucrative portfolio is in tailoring it to the investor's goals and constraints. Before you start looking for investments, you need to figure out how risk tolerant you are. It will give you some piece of mind if you make selections based on your risk profile.
A lucrative portfolio is dependent on being well-maintained, in addition to assessing the dangers. Staying up to speed on the stock market and assessing various risks and rewards may be a very hectic process.
To ease the process you must create some order; and here is where portfolio management comes into play.
What is Portfolio Management?
Portfolio management is the art of identifying an individual's optimal investment policy in terms of risk and return(Here).
The ability to make sound decisions is the foundation of the entire process. A decision like this generally entails putting together a good investment mix, allocating assets based on risk and financial goals, and diversifying resources to avoid losing money.
Portfolio management is mostly a SWOT analysis of alternative investment pathways, with investors' objectives balanced against their risk tolerance. As a result, it assists in the production of big profits as well as the protection of such riches from risks.
A portfolio, in other terms, is a collection of assets. The portfolio allows for risk diversification. Risk diversification does not imply that the risk will be eliminated. Diversifiable/unique/unexplained/unsystematic risk and undiversifiable/market risk / explained /systematic risk are two forms of risk associated with any asset.
Even the best portfolio can't completely remove market risk; it can only minimise or eliminate the risk that can be diversified. The variability of return decreases as risk decreases.
(Must check: Types of financial risk)
Why Is Portfolio Management Important?
Investing isn't something you do once and then forget about. Portfolio management does not imply that the portfolio is continually monitored, but it does imply that items are monitored on a regular and consistent basis.
Situations for investors might change. With the passage of time and life changes, their aims and ambitions may shift. These developments may need a portfolio repositioning.
From time to time, individual holdings may need to be replaced. A change in the management of an actively managed mutual fund is possible. This may prompt the portfolio manager to switch to a different fund holding.
It's also vital to have a portfolio strategy for investing. Some investors just build up a portfolio of separate assets with little regard for how their numerous investments interact. This can lead to an over-allocation of funds in a particular sector, exposing the investor to more danger than they may anticipate.
Types of Portfolio Management
Types of portfolio management
Active Portfolio Management
The goal of an active portfolio manager is to outperform the market in terms of returns. Those that invest in this way are often contrarian in their thinking. When stocks are cheap, active managers purchase them, and when they rise beyond the standard, they sell them.
The quantitative study of firms to evaluate the cost of stock in proportion to its potential is part of active portfolio management. The active manager does this by ignoring the efficient market hypothesis and instead relying on ratios to back up his assertion.
To reduce risk, the active manager seeks to spread his assets across several sectors. The problem with active portfolio management is that success is entirely dependent on the manager's ability. However, if you can locate one with the appropriate expertise, the value investing technique is likely to yield good results.
Passive Portfolio Management
The passive investment technique is the polar opposite of active management. The efficient market hypothesis is held by those who adhere to this idea. The idea is that a company's fundamentals will always be reflected in its stock price. As a result, the passive manager chooses to invest in index funds with a low turnover rate but high long-term value.
Your money is invested in index funds in a percentage-wise proportion to the market capitalisation. This indicates that for every Rs.100 invested in the 500 fund, Rs. 2 will be invested in the firm that represents 2% of the index.
The goal of choosing a lower yield is to save money on management costs while still reaping the benefits of stability.
Discretionary Portfolio Management
A discretionary manager is given complete discretion in making choices on behalf of the investment. While individual goals and timelines are considered, the manager chooses the plan that he believes is optimal.
After handing over the funds to the expert, the investor sits back and waits for the earnings to come in.
(Also check: What is risk management?)
Non-Discretionary Portfolio Management
A non-discretionary manager is nothing more than a financial advisor. He advises the investor on the best course of action. While the advantages and disadvantages are clearly stated, the investor is free to select his own course. Only until the manager has been given permission to act on behalf of the investor does he make a move.
Whether you hire a portfolio manager or do the task yourself, it's critical to pick a feasible approach and ensure that it's presented in a logical manner. Maintaining a reasonable portfolio has the advantage of reducing confusion while offering assets that are tailored to the individual's objectives.
A process of Portfolio management
Portfolio management process
Establishing investment objectives centers on identifying the investor’s risk-return profile. Determining how much risk an investor is willing and able to assume, and how much volatility the investor can withstand, is key to formulating a portfolio strategy that can deliver the required returns with an acceptable level of risk.
Once an acceptable risk-return profile is developed, benchmarks can be established for tracking the portfolio’s performance. Tracking the portfolio’s performance against benchmarks allows smaller adjustments to be made along the way.
Selection of the backup assets
Identifying alternative assets that may be included in the portfolio to distribute risk and limit loss is the next important stage in the portfolio management process.
The link between securities must be explicitly defined at this phase. Preference shares, equity shares, bonds, and other securities may be included in portfolios. The percentage of the mix is determined by the investor's risk tolerance and investment limit.
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Developing a strategy
Following the selection of an asset mix, the creation of an acceptable portfolio strategy is the next phase in the portfolio management process. There are two approaches to developing a portfolio strategy, notably
an active portfolio strategy; and
a passive portfolio strategy.
An active portfolio strategy uses market timing, moving from one sector to another based on market conditions, securities selection, or a combination of these to try to generate a higher risk adjusted return.
In contrast, a passive portfolio approach has a preset amount of risk exposure. The portfolio is well-balanced and well managed.
Analysing the security
In this phase, the investor actively participates in the selection of stocks.
Security analysis necessitates the information sources upon which the analysis is based. The price, potential return, and risks connected with the securities in the portfolio are all considered. Security analysis aids in understanding the type and amount of risk connected with a specific security in the market, as the return on investment is tied to the risk associated with the security.
Micro and macro analysis are both used in security analysis. Micro analysis, for example, involves studying a single script. Macro analysis, on the other hand, is the study of the securities market. Fundamental analysis and technical analysis aid in the identification of assets that can be included in an investor's portfolio.
Acting according to the plans
When the securities for investment have been chosen, the portfolio plan is put into action, which is the following step in the portfolio management process. The term "portfolio execution" refers to the purchasing and selling of certain assets in predetermined amounts. Portfolio execution is one of the most essential phases in portfolio management since it has an impact on investment performance.
One of the most crucial phases in portfolio management is portfolio modification. According to market conditions, a portfolio manager must continuously evaluate and review scripts. Adding or deleting programmes, switching from one stock to another, or switching from stocks to bonds and vice versa are all examples of portfolio revision.
In this phase, the performance of the portfolio is assessed over the stipulated period, concerning the quantitative measurement of the return obtained and risk involved in the portfolio, for the whole term of the investment.(Here)
(Also read: Introduction to Investment Banking)
Effective portfolio management is so important because it helps individuals to create the optimal investment strategy that fits their income, age, and risk tolerance. Investors may successfully decrease their risks and obtain personalised answers to their investment-related difficulties with competent investment portfolio management. As a result, it is a necessary component of each investment initiative.