Importance of Portfolio Management for Investors

Risk and return are the two important aspects of financial investment. Risk is the probability of incurring losses whereas return is an income earned through an investment. The higher the risk, the higher will be the return on investment and vice versa.  Individual investors like to minimise risk as much as possible. Let’s take an example of an equity trader, a person who buys and sells stocks. An equity trader takes some amount of risk while buying stocks since the stock market is unpredictable. He earns profits if the stock price goes up and incurs losses if the stock price comes down. Hence, there is an element of risk involved while trading stocks.

Analysis of risk and return

Let’s examine the risk and return of various investment options. You take no risk while buying debt since you get a fixed rate of interest on debt. You take risk while buying stocks since you do not get a fixed rate of return. A fixed deposit account holder assumes no risk since he/she anticipates the investment to be doubled over a period of time. Similarly, a currency trader assumes some amount of risk while buying currency pairs since the Forex market (Foreign exchange) is highly volatile in nature. An insurance buyer assumes no risk while buying insurance plans. Therefore, an investor who is exposed to more risk is likely to earn more returns than an investor who is exposed to less risk. 

 

Investment portfolio

Balancing the risk and return on a financial investment is very important. How does an investor balance these two elements? Yes, the risk and return of a financial investment can be balanced through constructing a portfolio. What is a portfolio? In finance, a portfolio is the grouping of financial assets such as equities or stocks, debentures, mutual funds, insurance schemes, futures, options and cash equivalents. Portfolios are managed by financial professionals and held by individual investors. Experts suggest that investors should build an investment portfolio in accordance with risk acceptance and investment objectives.

Portfolio management

A portfolio is a combination of investment options. On the other hand, portfolio management is an art and science of making decisions about investment policy and mix, balancing risk against performance, matching investments to goals, and allocating assets for institutional and individual customers. The management of a portfolio is all about comprehending weaknesses, strengths, threats and opportunities while choosing debentures and equities. As far as mutual fund and exchange-traded funds (ETFs) are concerned, there are two categories of portfolio management: 1) active and 2) passive. Active management encompasses a unit of managers whereas passive management tracks a market index.

Elements of portfolio management

The key elements of portfolio management include asset allocation, diversification and rebalancing. Asset allocation seeks to optimise the risk and return profile of an individual investor by investing in a combination of financial securities, which have the low correlation to each other. An investor with an aggressive profile can weigh his/her portfolio towards steady investments. Diversification, the second key element of portfolio management, spreads risk and return within an asset class. It takes place across various securities. Rebalancing, the third key element of portfolio management, is a method deployed to return a portfolio to its original target allocation at yearly intervals.

Why portfolio?

All types of investors need an investment portfolio to optimally invest. It can be constructed using both short-term and long-term investment choices. Like mentioned earlier, many people do not have expertise and knowledge to invest. Building an optimal investment portfolio helps investors to minimise risk and maximise returns. Asset management companies (AMCs) enable investors to invest in the best investment opportunities. They customise an investment plan on the basis of specific requirements, risk appetite and return expectations of customers. The customisation and continuous updates of portfolios assist investors to have a complete understanding of how and where their money is invested.

Best investment options

Let’s analyse the investments in properties and stocks. Investing in properties is entrusted to be the most rewarding option. A property investor can anticipate the price of the property to increase in the long-run. The cost of the property can be financed through a housing loan or a bank loan offered by financial institutions at attractive interest rates. You can opt either a fixed rate home loan or a flexible rate housing loan. You will certainly be benefited through investing in properties. Another option is buying a life insurance plan. If you want to earn more, consider investing in stocks.

Bottom line

The risk-return tradeoff is the fundamental principle. Low levels of risks are associated with low returns whereas high levels of risk are associated with high returns. As per the principle, investments can yield higher returns only if an investor is willing to accept the probability of losses. So, a portfolio should be intelligently constructed and managed.