Portfolio management is the process of selecting and monitoring investments over time. These decisions are informed by an investor’s personal goals, risk tolerance, and time horizon. While there are professional portfolio managers, it’s also possible for investors to manage their portfolio on their own.
Doing so requires understanding the basic tenets of portfolio management, which include concepts like diversification, asset allocation and rebalancing, investment fees, tax planning, and more.
Investors can also decide if active or passive portfolio management makes more sense for them and work toward building out a portfolio strategy tailored to their unique situation and goals.
Key Points
• Portfolio management is the process of selecting and monitoring an investment portfolio.
• A portfolio can be managed by a professional, by the investor themselves, or by an automated platform such as a robo advisor.
• Portfolio management is usually informed by the investor’s goals, risk tolerance, and time frame in order to create an asset allocation that’s well diversified, low cost, and tax sensitive.
• Portfolio managers are different from financial advisors, who are not necessarily involved in asset management.
• A portfolio manager typically focuses on the investment strategy, not on creating a personalized financial plan.
Portfolio Management Defined
As discussed, portfolio management involves a portfolio manager selecting and managing a group of investments with an investor’s financial objectives and risk tolerance in mind. Often, portfolio managers also rely on historical investment returns (and risk) as a guide for their investment strategy.
Building a Portfolio of Assets
When building a portfolio, investors may find it helpful to keep some of the foundational ideas of portfolio management in mind when investing online or through a brokerage.
This includes an asset allocation strategy that’s focused on diversification and risk management, and selecting securities with cost and taxes in mind.
For example, a portfolio manager might invest in the three primary asset classes: stocks, bonds, cash and cash equivalents (e.g. money market funds). Each asset class has its own risk/reward profile.
Stocks tend to be higher risk, but may offer profits over time. Bonds typically deliver smaller returns — but without the volatility and risk of stocks. Cash comes with an inflationary risk, but is typically stable and provides liquidity in a portfolio.
Asset Classes, Cost and Taxes
Of course, investors aren’t limited to those three asset classes. There are many more investors can choose from — as well as numerous investment instruments (i.e. types of mutual funds and exchange-traded funds (ETFs), derivatives, tangible or real assets, and more).
A skilled portfolio manager can combine a range of assets in order to create a well-diversified portfolio that’s cost efficient. Investing in mutual funds and ETFs, many of which come with lower expense ratios, for example, can add to portfolio diversification because each fund contains hundreds or thousands of stocks, bonds, or other securities.
Taxes also come into play, given that the location of assets — whether in a taxable or tax-deferred account, like a 401(k) or IRA — can have a significant impact on taxes owed over time.
Recommended: What Is Portfolio Diversification and Why Does It Matter?
Passive vs. Active Investment Strategies
Further, investors may want to learn the distinction between passive and active portfolio management, along with the variety of ways to implement their desired investment strategy.
• Passive investing. Broadly speaking, passive strategies track a market index — which is why they’re called index funds. The goal is not to beat a certain market’s performance but to mirror it. In addition to index mutual funds, most ETFs are considered passive. Passive portfolios typically come with lower management fees.
• Active investing. Active portfolio management, on the other hand, is generally handled by professional portfolio managers. They track a funds’ performance, deciding when to hold, buy, or sell various investments.
Here, the investment goal is to outperform (not mirror) the market’s day-to-day ups and downs.
Professionally invested portfolios often come with higher management fees, which are usually passed on as an added cost to the investor. However, not all of the tools of professional investment portfolio management are widely accessible to individual investors. For instance, professional investment managers often have access to analytical research, advanced algorithms, and costly industry tools.
Important Portfolio Management Strategies to Know
As mentioned, keeping the tenets of portfolio management in mind can help investors when building their investment portfolio. Here are some of the key portfolio management strategies to know about.
Basic Diversification
“Don’t put all your eggs in one basket,” is a familiar saying. The idea here is that it’s risky to bank on any single investment, no matter how sure of it the investor may feel. In classic portfolio management, portfolio diversification is the technique of buying multiple non-correlated investment types in order to lower a portfolio’s overall risk.
This makes a lot of sense when thinking of owning just one stock — it’s not wise to rest an entire investing strategy on the fate of just one company. By owning a well-rounded selection of stocks, the poor performance of one won’t sink the ship.
A properly diversified strategy can help mitigate some of the risks at every level of investment portfolio management — starting with the big-picture decision of whether to own stocks in the first place, and in what proportion. Integrating other asset classes into a portfolio may help to lower overall risk by lowering the exposure to a single asset type.
For example, with basic or naive diversification, as it’s called, an investor may find it too risky to invest all of their money in the stock market, so they might look to integrate bonds, real estate, and even cash into their strategy. That way, when the stock market takes a big dip, the investor won’t see the entire value of their portfolio go down. It may even be possible for other asset classes to gain while stocks fall.
Sophisticated Diversification
An investor could further diversify within each asset class. Within the stock market, that might mean owning stocks within different industries, or sectors, in different countries, and with varying investment “styles,” such as growth, value, or dividend-paying stocks.
For example, it may be less risky to own stocks that exist across all of the sectors than to own only stock in a single sector, like technology or health care.
Within the bond market, it’s possible to own corporate and government bonds (Treasury bonds or municipal bonds), along with bonds of varying maturities.
As noted, many pooled investment funds, like mutual funds or ETFs, are inherently diversified. It’s possible to buy a fund that holds a mix of stocks or bonds (or both) that support more sophisticated diversification.
Asset Allocation
How does one determine how much to allocate to stocks, bonds, cash, and so on? This is the question of asset allocation. Put simply, asset allocation is an investor’s breakdown of holdings by asset class — the big-picture investing decision mentioned above.
The most common asset classes are stocks, bonds, and cash. When investing within a workplace retirement account, like a 401(k) plan, asset allocation usually boils down to a mix of stocks and bonds. (Tip: Within retirement accounts, these asset classes may be referred to as equities and fixed income, respectively.)
Generally, asset allocation is determined by an investor’s goals, risk tolerance, and investing timeline. This is where investors might want to start, asking themselves questions like: What is my goal with this money? When will I need the money? And what level of risk am I willing to take?
Then, they can piece together those answers with the asset type, or blend of asset types, that make the most sense given each type’s typical performance and risk profiles.
For example, a person targeting long-term growth who is comfortable with risk may have a higher percentage of their portfolio allocated to the stock market, which has higher risk with a higher potential for return. Meanwhile, someone who is nearing retirement and wants a more conservative strategy may have more allocated to bonds and cash.
Imagine an investor with a “70/30” allocation, with 70% of their portfolio invested in stocks and 30% invested in bonds. If this person had $10,000 invested, that’s $7,000 invested in stocks and $3,000 in bonds.
Once an asset allocation is determined, the idea is to stick with it. Because remember, asset allocation is determined by an investor’s goals — not what is currently going on in the market.
Rebalancing
Over time, different asset classes and investment types gain and lose value unevenly. The point of diversification is to have investments that perform differently during different times and in different environments.
Therefore, asset allocations may get out of whack after a period of uneven growth. What remains could be a portfolio that no longer matches up with an investor’s goals. To keep a portfolio’s “balance” in check, the proportions may need to be readjusted. This process is called rebalancing.
Using the “70/30” example above, say that the portfolio’s stock piece grew faster than the bonds. After the disproportionate growth, stocks now make up 90% of the overall portfolio allocation, and bonds make up just 10%.
But this investor had already determined that a 70/30 split was more appropriate for their goals and risk tolerance. To rebalance, the investor would sell the overweight in stocks and buy back into bonds, which are currently under their desired weight. Or the investor could add to the lagging investment.
Occasional rebalancing is helpful in a number of other ways, too. For one, it encourages an investor to stick to a long-term plan. This may help when it’s tempting to make decisions based on the market’s current activity, which is often a bad idea.
There are different opinions on how often an investor should rebalance. It can be done monthly, quarterly, or annually, or on an as-needed basis as the portfolio grows over time.
Recommended: Stock Market Basics
Understanding Automated Investing Platforms
It’s also possible for an investor to utilize what’s known as a robo advisor, or an automated platform, to manage their investment portfolio.
Robo advisors don’t use robots and they don’t offer advice. Rather, the investor supplies some basic information (e.g., their goal, time horizon, risk tolerance) within the automated platform. On the back end, a sophisticated type of technology delivers a few low-cost portfolio options, typically consisting of ETFs.
Once the investor selects a portfolio, the automated platform manages that portfolio over time, rebalancing the asset allocation and in some cases providing some tax-loss harvesting.
While some investors may prefer a human portfolio manager, others appreciate the power and convenience of technology to handle these complex decisions.
Using a Benchmark in Portfolio Management
Portfolio managers often use a benchmark index to measure risk and performance. Typically, a benchmark is a broad market index for the investment’s corresponding market — like comparing a stock portfolio to a stock index.
For example, if an investor is building a portfolio of U.S. stocks, they might want to use the S&P 500 as a benchmark. The S&P 500 is a broad market index that acts as a proxy for the stock market as a whole, because it measures the performance of 500 of the biggest U.S. companies.
For a global stock portfolio, the MSCI World is a popular benchmark. For bonds, some portfolio managers may use one of Bloomberg Barclays bond indices.
A benchmark is not only used to measure performance but also to manage risk. When an investor builds a portfolio that they hope will best the market index, they’re also taking the risk that it could do worse. The further from the benchmark a portfolio deviates, the higher the potential for risk.
Passive and Active Portfolio Management
Whether investors go with an active or passive strategy, it’s still worth considering the tenets of investment analysis and portfolio management: diversification, asset allocation, rebalancing after periods of uneven growth, and the use of a benchmark.
Passive Portfolio Management
With a passive approach, the portfolio manager or investor looks to simply return the average of the markets they’ve invested in.
To do this, they may buy a broad market index fund. For example, an investor who wants to return the average of the U.S. stock market could buy an index fund, such as an S&P 500 index fund or a total U.S. stock market index fund.
Passive investing is popular among investors who believe that markets alone will outperform over time. No active management needed.
Such an investor may also believe that active management is a futile endeavor, as active managers ultimately tend to do worse than the stock market’s average anyway. Plus, index funds are generally lower in cost and have outperformed their managed peers.
Active Portfolio Management
There are a number of reasons a person would pursue active portfolio management — the primary one being that active investing is an involved, hands-on endeavor. Investors may go the active route because they get enjoyment out of actively managing their portfolios, and have confidence in their ability to keep their portfolios on track.
Active management also means the investor is willing to accept the risk of loss themselves.
The other meaning of active investing refers to actively managed mutual funds (which are different from passive funds). Instead of investing in a certain market sector via an index fund or similar passive strategy, an investor puts their faith in the skill of an active portfolio manager to deliver better-than-average results.
For this reason, actively managed funds tend to cost more than passive ones.
The Takeaway
Portfolio management is the process of selecting and maintaining a group of investments according to your objectives and risk tolerance. Though professionals offer portfolio management, investors can also rely on these tenets when building their own portfolios: including diversification, asset allocation and rebalancing, the impact of taxes and fees, and the use of a benchmark.
For investors who want a straightforward, less-involved type of portfolio management, using a robo advisor could be an option. These automated platforms collect some personal information, and from there the technology uses a sophisticated algorithm to provide a few basic portfolio options for investors — and manage the portfolio over time.
Ready to start investing for your goals, but want some help? You might want to consider opening an automated investing account with SoFi. With SoFi Invest® automated investing, we provide a short questionnaire to learn about your goals and risk tolerance. Based on your replies, we then suggest a couple of portfolio options with a different mix of ETFs that might suit you.
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