The Building Blocks Of Portfolio Management
Portfolio management: Its a phrase that conjures up the idea of hard work and complicated subject matter
. But with the right approach,
portfolio management can be a key to your long term investment success. Who knows, you may even have some fun with it along the way! Here are some basic building blocks to get you started in the right direction.
There are four important steps to portfolio management: investment policy formation, construction, execution and monitoring. Investment policy formation is where you make the important decisions about what you really want from this portfolio. In brief:
- What are my return objectives?
- How much risk am I willing to take on to achieve those objectives?
- What are the special considerations governing my choices, such as time horizon to major life events, liquidity needs, tax considerations and so forth.
Your answers to these questions will form the foundation of your investment policy. It is a good practice to put them in writing in the form of an Investment Policy Statement. This document can serve as a continual reminder of your goals and considerations, and can evolve over time as your circumstances and needs change.
The Investment Policy Statement feeds right into the next stage of portfolio management: construction. Your return objectives and risk tolerance form the basis for the weights given to risky assets like equities and less volatile securities like government bonds and cash equivalents. Your decisions to include, for example, more stocks from Indonesia or a higher percentage of 5-year US Treasury notes should be consistent with those risk/return considerations. Asset allocation is the process of evaluating appropriate asset classes for inclusion in the portfolio and setting weights for each class in accordance with the investment policy.
In addition to the asset allocation decision you also have to decide what type of instruments to include. Instruments include individual securities like stocks, bonds, options or futures, as well as pooled vehicles like mutual funds and exchange traded funds (ETFs). Pooled vehicles are advantageous as they reduce the amount of time you have to spend researching the characteristics of individual businesses (and the attendant risk of concentrating too much exposure into too few names). Jemstep has extensive resources on this blog and elsewhere on the website concerning mutual funds and ETFs.
Now that you have constructed your portfolio the next thing to do is actually put your decisions into action. This is the execution phase. Here you have to address some very pragmatic considerations, for example how you are going to execute the trades and where these assets will be held in custody. If you have an existing brokerage or investment advisory relationship you can obtain advice and assistance there. If not, conducting some research via the websites of well-known players in the field like Fidelity, Schwab or TD Ameritrade can be helpful.
When executing your decisions remember to keep the long term in mind. It can be tempting to want to play the market as you are building positions. Resist that temptation and follow a prudent approach like dollar-cost averaging over some defined period of time like two weeks or a month.
Having now formulated, constructed and fully invested your portfolio you may think the work is over but there are still things to do. Portfolio management requires ongoing monitoring and periodic decision-making. One decision that will come up at least once a year, if not more frequently, is portfolio rebalancing (please see Kevin Cimrings recent posting for a detailed account of this topic). Rebalancing is an important activity in order to keep the composition of your portfolio in line with its long-term objectives.
These long-term objectives themselves will probably change over time as your own life changes, and they will impact the risk/return profile described in your Investment Policy Statement. Periodically re-weighting your asset class allocation for example to pursue more capital appreciation or a more predictable income stream can help your assets to keep pace with your life. Finally, it is a good idea to keep tabs on your actual investments from time to time. How well did that large cap value mutual fund perform over the past five years? Is the commodities ETF I purchased for its low correlation to the S&P 500 working out the way I planned?
Portfolio management is not about making continual changes every day, and it is certainly not about moving in and out of assets every time some analyst chirps an opinion on CNBC. By methodically paying attention to a few key decisions and making the necessary tweaks on an ongoing basis, you can establish a foundation for long term investment success. For more information please Visit :
www.jemstep.comby: Jem Step
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