Back in 1951, an American economist named Harry Markowitz came up with the concept of the investment “portfolio”: an idea that seems so obvious now but at the time was absolutely revolutionary.
Back then, investors would usually put their money into one type of asset class. This left those investments vulnerable because general falls in their market would usually spread to drag down stocks’ value regardless of their individual strengths and merits.
Markowitz’s idea was for investors to better balance risk & return by having a variety of uncorrelated investments housed within a single theoretical portfolio. When viewed as a whole, the portfolio represented an investor’s entire body of work in the form of financial assets.
While there’s no physical holder like an actual portfolio, an investment portfolio can contain stocks and shares, bonds, cash, real estate, gold, intellectual property, art, cryptocurrency, collectibles and anything else of value with the potential to return an income over any term.
What does the ideal mix of assets in a portfolio look like today, and in what allocation proportions? It depends entirely on the investment strategy guiding a person’s “portfolio management”, which we explain next.
What is portfolio management?
Managing an investment portfolio is a recurring, long-term exercise made up of three primary elements:
- Selecting and buying the assets that will make up an investor’s investment portfolio. This is done on the understanding that some assets are more volatile than others but have a greater potential for growth. A diverse mix of growth and defensive assets is usually chosen to balance the risks with the returns.
- Monitoring the performance of each of those assets over time, to guide whether they’re held or sold as well as to provide an overall perspective of the portfolio’s evolving value. Regular rebalancing allows the opportunity to capture gains, expand into new growth opportunities, and explore tax minimisation options.
- Doing the above two elements in accordance with a cohesive investment strategy designed to achieve the short, medium and long-term financial goals of an investor, balanced by the investor’s tolerance for risk or potential loss.
Types of investment portfolio management
There are two main portfolio management strategies:
Active portfolio management
This involves taking a frequent and hands-on approach when making investment decisions. Fund managers or brokers are used to buy and sell individual stocks with the aim of outperforming the averaged-out returns of a stock market index such as the ASX 200 in Australia and the S&P 500 in the US.
Success depends on the latest research, market forecasting, expertise and dedication to ensure the purchase or sale of shares in specific companies is done at the most ideal times.
Due to the high level of involvement, an active approach should in theory increase the potential for higher returns from individual, high-performing stocks compared to the returns one could receive when just replicating the holdings on a certain index.
However, trying to actively outperform the broad movements of a certain market also involves additional risk. Indexing can significantly reduce this risk as losses made by a particular stock are usually offset by gains by others.
Passive portfolio management
Passive portfolio management involves buying a group of shares that track a broad stock market index. The aim is to mirror the stabler and more predictable returns of that market (or a specific grouping within it), and hold the investments over a longer-term.
Some fund managers or brokers simply buy the same basket of stocks that make up that index, such as the ASX 200 and the S&P 500, with the same weighting that those stocks are represented in the index.
By simply replicating the index, they avoid the task of assessing, tracking and selecting individual assets to be bought or sold.
Because they trade much less frequently and require less strategic input, passively managed index funds tend to incur lower fees and are also more tax-efficient.
How to manage an investment portfolio
There’s a lot at stake when making decisions about a diverse collection of investments that needs to be viewed as a whole to fully understand its performance. However, by following a few key principles like the four below, you’ll make it much easier to keep your portfolio well-balanced and consistently delivering good returns over the long term.
1. Set your goals and devise your strategy
Your goals should guide your asset mix, when to sell, and how to manage your portfolio.
So if you haven’t yet, ask yourself:
- What am I saving up for?
- When will I need access to my money?
- Is there anything else I need to achieve my goals?
You’ll likely have a different investment strategy for achieving short-term goals (like renovating) vs. long-term goals (like retirement). And factor in flexibility in case your goals change over time.
Ensuring your portfolio is made up of a variety of investment types helps insulate it against sudden changes in the market. The right mix of investments for you will be based on your age, your goals, your timeline, life milestones and your appetite or tolerance for risk. This information will help guide your decision making on which investment types you acquire, and in what weightings.
3. Rebalance at least annually
Market fluctuations can take your portfolio off track and away from your goals. That’s why you need to rebalance your portfolio every 6 to 12 months by shifting your money away from vulnerable parts of your portfolio to others more suitable for the times (e.g. from shares to property or vice versa).
4. Get hands on with managing your portfolio
When making investment decisions, always be sure to:
- Verify all fees
Find out in dollar terms exactly what you’re paying to get a clear picture on how much fees could be impacting your returns.
- Understand your tax obligations
Be aware of the tax implications of your investing decisions and always keep your records up-to-date.
- Be guided by your goals and strategy
From asset allocation to portfolio rebalancing and everything in between, be consistent and strategic rather than impulsive.
But most importantly, you need a reliable and accurate way to track your investments. Using an online portfolio tracker like Sharesight provides you with the latest price and performance data for your portfolio, plus access to a suite of advanced reporting tools – giving you the information you need to make informed investing decisions.