10.1 Portfolio Management: An Overview - 10.1 Portfolio Management: An Overview

Key Concepts

• Portfolio Management
• Investment Objectives
• Risk Tolerance
• Asset Allocation
• Diversification
• Performance Measurement

Portfolio Management

Portfolio Management is the process of constructing, monitoring, and adjusting a collection of investments to achieve an investor's financial goals. It involves strategic decision-making to balance risk and return.

Example: A financial advisor works with a client to create a portfolio that includes stocks, bonds, and real estate, tailored to the client's financial goals and risk tolerance.

Investment Objectives

Investment Objectives are the specific goals that an investor aims to achieve through their portfolio, such as capital preservation, income generation, or long-term growth. These objectives guide the portfolio management process.

Example: A retiree may have an investment objective of generating regular income to cover living expenses, while a young professional may prioritize long-term growth to build wealth.

Risk Tolerance

Risk Tolerance is the degree of variability in investment returns that an investor is willing to accept. It is influenced by factors such as age, financial stability, and investment knowledge.

Example: A risk-averse investor may prefer low-risk investments like government bonds, while a risk-tolerant investor may invest in high-growth stocks with higher volatility.

Asset Allocation

Asset Allocation is the process of distributing investments across different asset classes (e.g., stocks, bonds, real estate) to balance risk and return. It is a key determinant of portfolio performance.

Example: A balanced portfolio might allocate 60% to stocks for growth, 30% to bonds for income, and 10% to real estate for diversification.

Diversification

Diversification is the strategy of spreading investments across various assets to reduce risk. It aims to maximize returns by investing in different areas that would each react differently to the same event.

Example: Instead of investing all funds in a single tech stock, an investor diversifies by investing in a mix of tech, healthcare, and consumer goods stocks.

Performance Measurement

Performance Measurement involves evaluating the effectiveness of a portfolio's asset allocation and investment choices. It includes tracking returns, comparing to benchmarks, and adjusting strategies as needed.

Example: An investor compares their portfolio's annual return to a benchmark index like the S&P 500 to assess whether their investment strategy is outperforming or underperforming the market.