Portfolio management is a conglomeration of securities as whole, rather than unrelated individual holdings. Portfolio management stresses the selection of securities for inclusion in the portfolio based on that security’s contribution to the portfolio as a whole. This purposes that there some synergy or some interaction among the securities results in the total portfolio effect being something more than the sum of its parts. When the securities are combined in a portfolio, the return on the portfolio will be an average of the returns of the securities in the portfolio. For example, if a portfolio was comprised on equal positions in two securities, whose returns are 15% and 20%, the return on the portfolio, will the average of the returns of the two securities in the portfolio, or 17.5%. From this we will discuss the process of creating a diversified portfolio. The diversified portfolio is a theory of investing that reduces the risk of losing all your money when “all your eggs” are not in one basket. Diversification limits your risk an over the long run, can improve your total returns. This is achieved by putting assets in several categories of investments.
The portfolio process is as follows:
1. Designing an investment objective;
2. Developing and implementing an asset mix;
3. Monitoring the economy and the markets;
4. Adjusting the portfolio and measuring the performance
Due to the intensity of each of the four items, we will be covering only the first two.
1. Investment Objective:
This topic is broad and contains three major divisions. They are foundation objectives, constraints and major objectives.
Foundation Objectives: These objectives generally receive the most attention from investors and are determined by thorough determination of your needs, preferences and resources.
Return – you need to determine whether you prefer a strategy of return maximization, where assets are invested to make the greatest return possible while staying within the risk tolerance level, or whether a required minimum return with certainty is preferable, generating only as much return with emphasis on risk reduction.
Risk – There are many ways to assess the risk tolerance of any particular investor, from the least knowledgeable of investments to the very sophisticated investor. Besides the risk you are willing to take, there must be a measure of the risk associated with each security be considered for the inclusion in the portfolio. It is important to recognize the difference between the risk of an individual security and the risk of the portfolio as a whole. The risk of a portfolio is less than the average risk of its holdings, your risk tolerance should be matched to the risk of the overall portfolio and not to the risk of each security.
Inflation – Although some degree of inflation protection is needed, the extent will vary depending upon the time horizon...