What Is Portfolio Management?

Too many young people either delay or forget entirely to invest for retirement. Some distant date that is 30 or 40 years in the future can be difficult to imagine, let alone care about today. And, without guaranteed pensions from employers and just a relatively small amount from Social Security, investments are often the best solution to supplement retirement income (if any), otherwise, future retirees will often have a hard time paying for life's necessities.

One reason young people don't invest is they fail to understand stocks or basic concepts such as diversification and the power of compounding. But it's not hard to learn. There are many sources of investing information, such as this website. Moreover, the earlier you start, the more time you have to build your wealth and ride out bear markets and periods of high volatility. Because of this, young people should get a leg up on portfolio management.

Portfolio management refers to the process of selecting and managing a set of investments that align with an individual's financial goals. The goal of portfolio management is to maximize expected returns while minimizing risk by holding a diverse range of assets. This process entails various strategies such as diversification, asset allocation, and risk management. The sooner you begin, the more time your investments will have to grow. Here we'll discuss some good ways to go about building a portfolio and how to manage it for the best results.

What Is a Portfolio in Investing?

A portfolio is a collection of investments consisting of various asset classes, such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). The purpose of a portfolio is to achieve a balance between risk and return by selecting assets that are not highly correlated and align with an individual's financial goals.

The word "portfolio" comes from the Latin folium, meaning to "carry leaves" (as in papers). Stock and bond certificates were once only issued in paper form, from which this terminology was adopted. For similar reasoning, a portfolio is also used to describe an artist's collection of works.

How to Build a Portfolio

When building a portfolio, it may be tempting to select stocks from companies that you are already familiar with, or which appear to be hot stocks in the media or online. However, this is not usually the best way to build a smart portfolio. Instead, seek out a wide range of stocks from different industries, and also diversify across different asset classes beyond stocks, such as bonds, real estate, commodities, and even a small allocation to cryptocurrency. Holding a variety of securities across different asset classes can help balance out the risks and returns of the portfolio, and help mitigate the impact of market downturns on any one particular investment or group of investments. Building a portfolio involves several steps.

• First, it's important to determine your investment goals. These can be segmented by time horizon, with long-term goals like retirement layered onto more medium-term goals like a down payment for a house or a child's college education.
• Second, evaluate your risk tolerance—from conservative to aggressive, or in between. This includes your capacity to take on risk related to your age, time horizon, income, and financial situation, and your willingness to take on risk.
• Next, you'll need to select a mix of assets that align with your goals and risk tolerance. It is important to have a good degree of diversification, which involves selecting assets from different asset classes, industries, and regions to spread risk without sacrificing expected return. In general, a more aggressive risk tolerance will feature a greater allocation to stocks, while a more conservative portfolio will hold relatively more bonds and cash (see the example Figures below)
• Once you have selected your assets, monitoring and adjusting your portfolio periodically is important. This involves rebalancing your portfolio to align with your investment goals and risk tolerance.
• If your goals or circumstances change or evolve, you may have to return to step one and begin the process again.

Example of An Aggressive Portfolio:

Example of A Conservative Portfolio

Why Diversification Is Key

You've heard the old adage, "don't put all your eggs in one basket," we've already mentioned that smart portfolio management involves diversification across asset classes and through holding various securities within each one. This reduces the impact of any asset or security on the overall portfolio. The goal is to hold a range of securities that are not highly correlated with one another. When two assets are highly correlated, their prices tend to move in the same direction simultaneously. For example, if you own two stocks in the same industry, their prices may rise and fall together based on the same industry-specific factors. On the other hand, holding assets that are not highly correlated means that their prices are less likely to move together, and may even move in opposite directions. This means that when one asset or security performs poorly, it is more likely to be balanced out by the positive performance of another asset or security. Thus, it is smart to hold to different asset classes and securities from various industries and geographic regions. Another way to diversify your portfolio is by investing in a mix of small, medium, and large companies. Often, larger companies have already succeeded, while smaller companies may be seen as more risky. However, smaller companies can also have greater potential for growth, which can help balance out the portfolio's overall risk. For instance, stocks may falter during an economic downturn while bonds and gold might perform better. By holding a mix of assets across different asset classes, the losses in the stock portion of the portfolio may be balanced out by the gains in the bond and gold portions, reducing the overall impact of the market downturn on the portfolio. An easy way to achieve good diversification, for beginners and seasoned investors alike, is to index mutual funds and ETFs replicating broad asset class benchmarks like the S&P 500, Nasdaq 100, or the Aggregate Bond Index. Index funds provide this diversification at very low cost are readily available through a variety of fund providers - so building a portfolio around various index products can be a smart and cost-effective strategy.

Why Is Portfolio Management Important?

Portfolio management is essential for achieving financial goals while minimizing risk. Without the proper planning and management, however, your portfolio can become unbalanced, subject to concentrated risks, and fail to meet your long-term goals. Winging it, following the crowd, going with your gut, or other types of uninformed portfolio construction can indeed be detrimental to your financial health. A well-managed and diversified portfolio, on the other hand, can provide investors with higher returns and help them weather market downturns.

Because of its importance, it is often best to get an early start. Even if you don't feel comfortable opening a brokerage account right away, participate in your company's 401(k) retirement plan. If a 401(k) plan is not available through your employer, establish instead an Individual Retirement Account (IRA) and earmark a percentage of your monthly compensation for a contribution to the account. An easy, convenient way to save in an IRA or 401(k) is to create an automatic monthly cash contribution.

Another reason to start managing your portfolio right early on is that the younger you are, the less likely you are to have certain financial obligations yet, such as those related to a spouse, children, and a mortgage, to name a few. Without these expenses, you can allocate a portion of your investment portfolio to higher-risk investments, which can yield higher returns over the long run. You'll probably also have more cash available for investments and a longer time horizon before retirement during your younger years. With more money to invest for more years ahead of you, you'll be on your way to having financial security and a more comfortable retirement nest egg.

Best Practices for Portfolio Management

There are several best practices for portfolio management. Here are a few key strategies to keep in mind:

1. Start with a plan: Before investing, it's important to establish your financial goals and risk tolerance. Take the time to think this through carefully, and reflect and reconsider your goals occasionally as your circumstances change and evolve.
2. Research your investments: If you are actively managing your portfolio by choosing what stocks and other securities will go into it, understand the assets and securities in your portfolio, including their risks and potential returns. Research potential investments before making a purchase and continue to stay informed about how your investments are performing over time. If you don't have the time or knowledge to do your own due diligence, look instead to index funds and ETFs or automated platforms like Robo-advisors.
3. Stay diversified: By investing in a mix of assets and securities, investors can reduce their exposure to any single asset or industry without sacrificing expected returns. Index funds and ETFs are an easy way to stay diversified, but pay attention to overlapping holdings that can undermine your efforts—for instance, if both the S&P 500 and Nasdaq 100 have Apple (AAPL) stock as a top holding, you're effectively doubling up on that stock and amplifying that risk.
4. Monitor regularly and rebalance: It's important to periodically monitor and adjust your portfolio to ensure it remains aligned with your investment goals and risk tolerance. Your asset allocation will change naturally due to market fluctuations, such that if stocks rise and bonds fall, your portfolio's weighting to stocks will increase relative to bonds. Rebalance your portfolio by adjusting your stake in each category to restore your original weightings.
5. Keep costs to a minimum: Management fees, trading commissions, and other costs can drag your portfolio's performance. Luckily, today many online brokers offer zero-commission trading in most stocks and ETFs, and the expenses on ETFs and mutual funds have also decreased considerably. Still, consider costs and use strategies like tax-loss harvesting to minimize your tax bill.
6. Consider the long term: Investing is a long-term game. It's important to maintain a disciplined approach and not be swayed by short-term market fluctuations that can trigger emotions like fear and greed. Make sure that you stay the course and put money into your investments on a regular, disciplined basis. This may not be possible if, for example, you lose your job, but once you find new employment, continue to put money into your portfolio.

Remember that no investment strategy is foolproof, and even the most carefully constructed portfolio can be impacted by unexpected events, recessions, or market disruptions. However, by following these best practices and maintaining a disciplined, long-term approach to investing, you can help maximize your chances of achieving your financial goals.

The Bottom Line

Portfolio management is the process of selecting and managing investments that align with an individual's financial goals. The goal of portfolio management is to maximize expected returns while minimizing risk. To build a smart portfolio, one should seek to include a wide range of stocks from different industries, regions, and company sizes, and to diversify across different asset classes. It's important to first determine your long-term investment goals and evaluate your risk tolerance, and it is also important to monitor and adjust your portfolio periodically. Less hands-on investors can still achieve cost-effective portfolio management through financial advisors or algorithmic platforms such as roboadvisors.