How to manage your investment portfolio optimally
How
to manage your investment portfolio optimally
Written by Tao Elyaalo
Portfolio management - or financial
portfolios - is seen as the art and science of making decisions related to
investments and the policy followed in managing them, aligning investments with
objectives, methods of distributing profits of financial assets to individuals
and institutions, and weighing risks against performance. It is also fully
concerned with identifying the strengths, weaknesses, opportunities and risks
in choosing debt versus net assets, domestic versus international investment,
and growth rates versus financial security. And many other investment exchanges
that are encountered in an effort to maximize return at a certain level of risk
appetite.
First: Understanding portfolio management
Although the terms “portfolio management”
and “financial planning” are commonly used as synonyms, these basic elements in
the world of financial services are not the same. As the management of
investment portfolios is the process of creating and maintaining an investment
account, while financial planning is the process of developing financial goals
and developing an action plan to achieve them.
As a professional portfolio manager;
Responsible for managing portfolios on behalf of others, while individuals may
turn to self-management of their investments and build their own investment
portfolios.
The ultimate goal of portfolio management
is to increase the expected return on investments with an appropriate level of
risk ratio.
Portfolio management in general can be either
passive or active:
Passive portfolio management is a long-term
strategy based on the principle of creating, controlling, and then forgetting
an investment portfolio. It often involves tracking an indicator or a group of
indicators. This type of management is usually referred to; By investing
according to the market index (Indexing or Index investing).
Active portfolio management - effective
management - includes a single manager, co-managers, or a team of managers;
Those who try to outpace market returns - that is, achieve profits that
outweigh market returns - by actively managing portfolios of mutual funds; By
making investment decisions based on research related to market trends,
economic transformations, changes in the political landscape, and factors that
may affect specific companies. This type of management is most often found in
closed-end funds, which are usually actively managed.
Based on the above, and before we begin
delving deeply into this topic, bear in mind the following:
Portfolio management is the process of
building and maintaining an appropriate investment mix to take risks.
The main factors of any portfolio
management strategy include: Asset allocation and diversification, and the
rules for rebalancing debit and credit accounts.
Active management of the investment
portfolio seeks to overcome the market index (achieve high investment returns)
by distinguishing financial assets that are lower in terms of market value
(Undervalued assets), which are often reached through short-term deals, and to
establish the optimal moment to invest in the market. timing).
Passive management of investment portfolios
(indexed financial / investment portfolios: portfolios that are linked to a
reference index of one of the trading markets) seeks to maintain the
performance of the portfolio similar to the performance of the market index
rather than outperforming it, while keeping costs and fees at a minimum.
Second: The main elements of portfolio
management
1. Asset Allocation:
The key to effective portfolio management
is the long-term asset mix. Asset allocation is based on the realization that
different types of assets do not work harmoniously. Some are even more volatile
than others.
Asset allocation seeks to optimize the
risk-reward ratio for investors, by investing in a mix of assets with a low
relationship with each other. Bolder investors can tip their portfolios towards
more volatile investments. As for the more conservative investors, they can tip
the balance of their portfolios towards more stable investments.
Indexed portfolios may use Modern Portfolio
Theory (MPT) to help build an ideal portfolio, while active managers may use
any number of quantitative and qualitative models.
2. Diversification of assets or investments
within a single portfolio (Diversification):
The only inevitable truth in investing; Is
that it is impossible to constantly predict winners and losers. Thus, a wise
approach is to create a basket of investments that provide a broad spectrum of
asset classes. As diversification as an idea; It is the distribution and spread
of risks and returns within different asset classes.
Since it is difficult to know which subset
of asset classes or financial sectors will outperform the others,
diversification seeks to obtain returns from all assets over time, but with
less volatility. Accordingly; Sound diversification occurs within different
classes of stocks and securities, sectors of the economy and different
geographic regions as well.
3. Rebalancing:
It is a method used to return the portfolio
to its original target allocation according to annual periods. It is important
for portfolios to maintain a combination of assets that best reflect the return
on risk versus the investor.
Otherwise, the fluctuations that may occur
in the markets could expose the portfolio to more risks, or reduce the chances
of achieving returns. For example, a portfolio that starts with a distribution
of 70% equity versus 30% fixed income could convert to an 80/20 distribution.
This is due to an overestimated boom in the market, which exposes the portfolio
to more risks than the investor can tolerate.
Rebalancing always requires the sale of
high-priced and low-yielding securities, and the redistribution of proceeds and
profits to be allocated to low-priced, high-profit stocks and bonds.
Repeating this process annually allows
investors to obtain gains and profits from investment portfolios, and to
increase growth opportunities in sectors with high potential while maintaining
a portfolio that is best aligned with returns versus risk for the investor.
Third: Active management of the investment
portfolio
Investors who apply an active approach to
managing portfolios use fund managers or financial intermediaries to buy and
sell stocks, in an attempt to outpace the expected returns of an index, such as
the S&P 500 or Russell 1000 index.
An investment fund managed in this way
contains a single portfolio manager, group of co-managers, or a team of
managers who make the investment decisions for the fund. The success of investment
funds managed according to this method depends on a combination of in-depth
research and market forecasting, and the experience and sophistication of the
portfolio manager or management team.
Portfolio managers involved in active
investment pay close attention to market trends, changes in the economy and
political landscape, in addition to factors that may affect specific companies.
This data is used to time the buying and
selling of investments in an effort to take advantage of the erratic trading of
stocks and market indices. Active managers claim that these operations will
increase the likelihood of achieving returns higher than those achieved by
simply simulating stocks or other securities included in a particular index.
Since the goal of a portfolio manager in an
actively managed fund is to outperform a market index, he has to assume
additional market risk to obtain the returns needed to achieve this end.
The indexing process eliminates these
additional risks since there is no risk of human error in choosing the shares.
These index funds are also traded less frequently, which means that they are
less prone to expenditures and more tax-efficient than their actively managed
counterparts.
Active management usually charges high
fees, and recent research has raised doubts about the ability of managers of
these investment portfolios to consistently outperform market indicators.
Fourth: passive management of the
investment portfolio
Passive portfolio management, also referred
to as "index fund management", involves creating a dedicated
investment portfolio to track the returns of a market index or "benchmark
index" as much as possible.
Portfolio managers resort to stocks and
other financial instruments traded within the index and apply the same
weighting process that is followed in them. The purpose of passive portfolio
management is to generate investment returns similar to the index that was
selected, rather than outperforming it.
A passive management strategy does not
involve a management team making investment decisions. Rather, portfolios are
organized in the form of ETFs, mutual funds, or investment trusts.
Index funds are classified as passively
managed, because each of them has a portfolio manager who brings the
performance of its portfolio close to the performance of the general stock
index, which represents the average price of most important companies listed in
the market. This is instead of trading securities based on his knowledge of the
risk and dividend characteristics of various stocks and financial instruments.
Because this investment strategy is not
proactive or active, the management fee that is set in portfolios and passive
index funds is often much lower than that of active management.
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