Posted by What Is Portfolio Management?
Playing the markets, whether as a trader or an investor, is more of an art form than a scientific process. That said, portfolio management has evolved to the point where one can classify it as science. At the very least, it incorporates a lot of the principles of statistics in trying to create wealth over the long term for its practitioner.
Basically, there are two approaches to managing a portfolio: active or passive management. The former attempts to beat the market, as measured by a benchmark market index, while the latter wants to track it.
Diversification
Using the thesis that it’s impossible to pick winners and losers consistently, diversification lets an individual reduce the risk of their portfolio via a basket of investments that provides broad exposure within an asset class. This may reduce the reward component as well, but the probability of higher long-term returns is greater. Fund managers and investors often diversify their investments across asset classes and determine what percentages of the portfolio to allocate to each.
KEY TAKEAWAYS
- A portfolio can be diversified within and across asset classes.
- Diversification attempts to smooth out unsystematic risk — the risk that is specific to a company or industry.
- A key point of diversification is that the different securities should not be perfectly correlated.
Asset Allocation Strategies
Asset allocation is crucial to creating a balanced portfolio. Finding the proper mix of stocks, bonds, cash, and real estate in your portfolio is a dynamic process and reflects the individual’s goals at different points in time as they grow older. For example, a 30-year-old just starting the investing process will have very different goals from a 60-year-old nearing retirement.
There are many asset allocation strategies, both passive and active, but the most common ones are strategic asset allocation, constant ratio allocation, and dynamic asset allocation.
KEY TAKEAWAYS
- Strategic asset allocation lets the investor set target allocations for various asset classes and rebalances the portfolio periodically.
- Constant ratio allocation continually rebalances the portfolio to its original mix.
- Dynamic asset allocation adjusts the mix of assets based on macro trends in either the economy or the stock market.
Setting Up a Watchlist
A watchlist is a list of securities, like stocks, that an individual is interested in as potential investments. Typically, these are stocks that an investor would buy if either their desired price was reached or the right catalyst for a sustained move existed.
Nowadays, most online brokerages allow investors to create their own watchlists based on their filtered criteria. For example, an investor could be watching certain stocks whose price-to-earnings (P/E) ratio is less than 20 but more than 15 and would like to buy them if it got below 15.
KEY TAKEAWAYS
- A watchlist can help an investor track securities and stay abreast of financial news or other news that could impact these instruments.
- Setting up a well-organized watchlist requires an understanding of the markets, seasonality, sentiment, and economic cycles.
- Some trading platforms offer curated watchlists based on popular investment criteria.
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