What is Portfolio Management? Definition, Types & Objectives
Although managing your own investments may seem daunting, you can still manage your portfolio.
You can look into index funds if you are just starting out. Or automated portfolios if your portfolio is too complex. A financial advisor or wealth advisor might be better suited for you if your financial situation is more complex.
What is a Portfolio?
A portfolio is an entire portfolio of financial assets that a person or institution has. This could include stocks, bonds, and mutual funds, as well as real estate, cryptocurrency, art, and other collectibles. A portfolio is a collection of all your investments. These investments may not always be in the same account.
Portfolio Management Definition
Portfolio management is an integrated strategy for investing that takes into account your goals, timeframe, and tolerance for risk. Portfolio management is the selection of investments, such as bonds or stocks, and their monitoring over time. Portfolio management can either be performed by you, a professional or via an automated service.
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Portfolio Management: Key Takeaways
- Portfolio management services can vary in cost: Some are completely free, while others may charge 1% or more of your assets.
- There are two major strategies for managing portfolios: passive and active management.
- Portfolio management includes concepts like asset location, diversification, and rebalancing, as well as tax minimization.
Active vs. passive portfolio management
There are two main strategies for managing portfolios: passive and active management.
Active Portfolio Management:
Portfolio managers who are active take an active approach to making investment decisions. Investors pay a percentage of assets managed by them. They aim to exceed an investment benchmark (or stock exchange index). High portfolio management fees can hurt investment returns. Clients pay up to 1% per year for advisory fees. This is why passive portfolio management has become more popular.
Passive Portfolio Management:
This is a way to choose investments that track a broad index of the stock market. The objective is to match the returns of the market over time (or a portion thereof).
A Robo-advisor, which is a service that uses computer algorithms to select and manage your investments on your behalf, works in the same way as traditional portfolio managers. You can set your parameters (your goals and time horizon, risk tolerance, and risk tolerance). Although Robo-advisors usually charge a percentage of assets managed there is not much need for active investment management, the management fees are typically between 0.25% to 0.50%.
You can get more help with investment account management and financial planning advice by using services such as Personal Capital or Facet Wealth. These services combine low-cost automated portfolio management with traditional financial planning advice. Advisors can provide guidance on how to save, invest, and protect your money. You will meet with your financial advisor via video or phone.
Things to Remember About Portfolio Management
Portfolio management doesn’t just involve managing and building an investment portfolio. These concepts can help you make smart investments and manage them well.
Asset location answers one question Where are your investments going? There are many options available. Your investments will be sheltered by the type of account that you choose. It is important to choose the best investment account for your goals.
The choice between tax-advantaged and taxable accounts is an important part of choosing an investment account. This choice can have long-term and short-term tax consequences. Designated retirement accounts, such as IRAs or 401(k), are best for retirement savings. These offer tax benefits, for example, Roth IRAs allow you to grow your money tax-free. Learn more about Roth IRAs, and the tax benefits. A standard taxable account can also be useful for investing in non-retirement goals, such as saving for a downpayment.
Asset allocation is similar to asset location but refers to how your portfolio splits up among different types of investments. This usually depends on your tolerance for risk. If you have longer to live before retirement, you may be able to invest more in riskier investments. You may consider an asset allocation that has a greater proportion of less risky investments if you are closer to retirement.
Diversification is the practice of spreading your investment dollars among different companies, geographies, and industries. This ensures that your entire portfolio is protected in the event of a collapse in one industry. Funds, which are basically baskets of many different securities, provide more diversification than investing in one stock.
Portfolio managers balance their accounts by rebalancing. Portfolio managers do this in order to maintain the original target allocation. This is the percentage of the portfolio that is invested in riskier investments than those which are less risky. Market fluctuations can cause portfolios to drift from their original goals over time. Learn how to rebalance your portfolio.
Tax minimization refers to the process of finding a way to pay less in taxes overall. These strategies are designed to reduce or offset an investor’s exposure for future and current taxes. This can have a significant impact on an investor’s return. To avoid costly surprises from the IRS, tax-efficient investment is important.
It all comes together
Portfolio management is a real-world process that combines all these elements into a personalized portfolio. An investor might be looking to retire in five years but doesn’t want too much risk. Their employer has a 401 (k), which is their asset location, where they can put a portion from their paycheck. They could have 50% stocks and 50% bonds as their asset allocation. If the ratio changes, an investor could end up with a portfolio that is closer to 55% stocks. This would make their portfolio riskier than they are used to. An investor or portfolio manager would then rebalance their portfolio to return it to the original 50/50.
Asset location can be a key factor in tax minimization. You can reduce your taxes by locating your assets in a Roth IRA. Qualified Roth distributions will be tax-free when you retire.
How to Manage Your Portfolio
The four key factors that guide portfolio management decisions include the investor’s goals, timeline, and tolerance for risk.
1. Setting goals
How much money you should save, what investment strategy to use, and which account type to use to reach your goals, are all factors that will determine how well you can save.
2. How much assistance do you need
Some investors prefer to make their own investments, while others are happy for a portfolio manager to do so. A Robo advisor may be a good option if you are having trouble deciding. These services are extremely affordable. Although portfolio managers are more expensive than a Robo advisor, they will usually offer customized portfolios and other services that go beyond the basics of portfolio management such as financial planning.
3. Your timeline mapping
When will you need the money? Is that date fixed or flexible? The timeline will help you decide how conservative or aggressive your investment strategy should be. Investment goals can be broken down into short-, medium- and long-term time frames. These are generally defined loosely as three years, three- to 10 years, and 10 years. You will want to reduce your exposure to short-term volatility if you, for instance, need the money in three years.
4. Determining your tolerance for risk
Diversification decisions are influenced by an investor’s willingness and ability to take on risks. Higher-risk investments can yield higher returns, but they may be subject to greater volatility in the short term. You want to strike the right balance between risk and reward, choosing investments that will help your goals while not keeping you awake at night worrying.
Portfolio management vs. wealth management
Portfolio management focuses on a client’s investment portfolio, and how assets are best allocated to meet their risk tolerance and financial goals. Wealth management is the most advanced level of financial planning and includes services like estate planning and tax preparation.