What is Portfolio Management?

21 Sep 2021  Read 3633 Views

Portfolio management is much more complicated than stock analysis. Don’t believe us? Listen to legendary economist Adam Smith: “There is a personality difference between the people who are good at finding stocks and the people who call the shots on timing and manage the whole portfolio. Security analysts dig down information and come up with an idea about what should be bought or sold, but they do not necessarily make good conductors for the whole orchestra. [..]”

So, today we'll look into portfolio management and all you should consider before building your portfolio. Let’s get on it, shall we?

Meaning of Portfolio Management

Portfolio Management is the process of effective management of various asset classes in a portfolio. As Investopedia defines it- “Portfolio management is the art and science of selecting and overseeing a group of investments that meet the long-term financial objectives and risk tolerance of a client, a company, or an institution.”

Errr! Too tough! Too complex! 

So, let's simplify this further. All the avenues in which you invest make up your portfolio. It could be stocks or bonds or fixed income instruments or commodities or real estate or precious metals or anything for that matter. Portfolio Management is the process of deciding how many asset classes to include, how much to allocate to each asset class and when/how to rebalance the portfolio.

Okay, but why is portfolio management important?

We’ve got all the answers for you. Let’s take the following situations into consideration. Suppose you are investing in equity shares, and you think you have spotted the next multi-bagger, and invest all your wealth in it. Unfortunately, your research and calculations turned out to be incorrect, and it was a wolf under the sheepskin. If you invested in FD in a bank and that bank turned out to be a PMC bank. If you invested everything in Bitcoin as soon as Elon Musk tweeted, it crashed due to the sudden rally! 

Just imagine the amount of hard-earned money you would lose. It’s scenarios and situations like these that make building a diverse portfolio very important.

Key Elements of Portfolio Management

Three main elements of portfolio management are:

  • Asset Allocation

Asset Allocation answers the questions ‘where to invest’ and ‘how much?’. A first-time earner might prefer equities, but a near-retiree might allocate more towards fixed income instruments. Likewise, someone with good knowledge of real estate might first choose to invest in different commercial properties, then in equities, and then in bonds. It all depends upon the individual’s age, goals, risk appetite, time horizon, etc. 

  • Diversification

Various asset classes react to different economic events differently. E.g., During 2008, all asset classes failed, yet Michael Burry made money out of the crisis. (Fine skills!) Diversification reduces the volatility of your portfolio and protects your downside, just like a cozy security blanket.

No one can explain the importance of diversification to you better than the legend himself, Ray Dalio. According to him, “The most important thing you can have is a good strategic asset allocation mix. So, what the investor needs to do is have a balanced, structured portfolio – a portfolio that does well in different environments. We don't know that we're going to win. We have to have diversified bets.”

Proper diversification, or as markets call it, ‘all-weather investing,’ ensures that your portfolio performs well in a dynamic scenario, and hence, Diversification is essential.

  • Portfolio Rebalancing

Under rebalancing, we shuffle and reallocate funds to asset classes periodically. It is necessary to know which investments are fruitful and from which to withdraw money. As time passes, rebalancing your portfolio according to your needs is a must (just like updating your resume).

As the popular management consultant Peter Drucker notes - "Investors who invest independently and portfolio managers who invest for the public at large must revisit their investments time and again because success and failure of a portfolio is based upon multiple characteristics, which are further based upon diverse probabilities. One must look and relook into their portfolio to make it more updated as per the recent trends because the only thing we know about the future is that it will be different.” 

So, show the world how adept you are with changing trends.

Types of Portfolio Management

Based on how one’s portfolio is handled, we can divide it into four types:

  • Active Portfolio Management

Here, the portfolio managers actively buy and sell securities to ensure maximum profits to their investors.

  • Passive Portfolio Management

Here, the portfolio is already ready based on the current market scenario, and you just need to invest in it. In a passive portfolio, there won’t be anyone to rebalance the portfolio continuously.

  • Discretionary Portfolio Management Services

In a discretionary PMS model, the manager designs and plans the portfolio strategy, manages funds, allocates capital, and diversifies according to the investor’s profile. He’ll look into every detail of an individual and his family, like which insurance to buy, which bonds to sell, whether to invest in crypto, etc. The portfolio manager ensures that every penny paid to him is worth it.

  • Non-Discretionary Portfolio Management Services

In a non-discretionary PMS model, fund managers can only advise their clients on investments. Whether to follow the advice or not is all up to that individual.

The only downside of the last two categories is that SEBI has announced a minimum capital requirement of 50 lacs to start investing in PMS. Sighs!

We know a majority of Indians won’t be able to meet that criteria yet. But don’t you worry; you won’t be devoid of a healthy financial future for long!

Finology brings to you the most intelligent financial planning platform, which understands you, your goals, risk appetite, and financial position, and accordingly, it suggests the ideal asset allocation. And that’s not all! We even offer scientifically sorted and expert-curated stocks and mutual funds recommendations just for you. Sign up to Recipe by Finology now!

Conclusion

Portfolio Management, being an inherent part of financial planning, is a very subjective matter. It depends upon several combinations of factors like age, goals, risk appetite, etc. Naturally, strategic portfolio management would require rigorous permutations and combinations of these factors plus boatloads of financial and industry knowledge. This is why it’s a complicated affair for most. You were right, Mr. Adam Smith!

If you can absolutely nail it, well and good. If not, don’t worry. Recipe is at your service.

About the Author: Amol Nakashe | 11 Post(s)

Amol has completed his Electronics Engineering from VIT, Pune. But his passion for the stock market intrigued him in pursuing MBA in Finance. He is a keen reader of topics related to stock markets and follows market updates religiously.

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