Investing your money in stocks, bonds and other assets can grow your wealth much quicker than leaving it in your bank account. In fact, many savings rates do not keep up with the rate of inflation, and that eats away at your purchasing power.
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While the benefits of building a portfolio are easy to understand, portfolio management isn’t so simple. Do it right and you can achieve your financial goals sooner. However, taking the wrong approach can leave you worse off than when you started.
Investors have several choices for how they can go about managing their portfolios. This guide will help you understand your options and help simplify portfolio management.
— What is portfolio management?
— Types of portfolio management.
— Examples of portfolio management.
What Is Portfolio Management?
Investors tend to accumulate several positions instead of going all-in toward a single equity or asset. Portfolio management involves deciding which investments to buy and making decisions on what to do with the assets.
Some people manage their own portfolios and do their own research when buying individual stocks. Other people let a fund manager oversee their portfolios and do the work for them in exchange for a fee.
Whether you want to manage your own portfolio or get help in this area, it’s important to know how the process works. Eric Croak, a certified financial planner and president of Croak Capital, explains what portfolio management entails: “The process of managing a portfolio includes steps like updating the original investment plan, looking back at past goals, and closely watching market trends. It’s important to understand that portfolio management isn’t just about creating and taking care of an investment portfolio. It also involves other concepts, such as asset allocation, risk management, security selection, diversification, etc.”
Types of Portfolio Management
There are several ways people can manage their investment portfolios. The four distinct types of portfolio management are active, passive, discretionary and non-discretionary management.
Active Portfolio Management
Investors who take a more active approach spend more time in their portfolios. They may also invest in actively managed funds that aim to outperform the market. While active portfolio management involves more work, or higher fees if you use a fund, it has its rewards.
Christopher M. Naghibi, executive vice president and chief operating officer at First Foundation Bank, explains how active portfolio management can lead to outperformance: “Active managers aim to outperform market benchmarks and indices by exploiting short-term price fluctuations, selecting undervalued stocks or sectors they expect to perform well.”
Naghibi adds, “This typically means that active management is a lot more flexible and can allow for quicker decision-making in response to market changes. So managers can take advantage of investment opportunities as they arise.”
However, be sure to do research on the fund manager and review their track record, or the historical returns of the funds they’ve managed.
Overall, this path comes with higher fees for funds as well as greater risk for DIY investors.
Passive Portfolio Management
Passive portfolio management is a simpler approach to investing. This philosophy involves buying funds that track a popular index like the S&P 500 or Nasdaq 100. Managers readjust their portfolios every few months based on changes to the benchmark.
“Passive managers think that over time, just investing in an index like the S&P 500 will bring better results than actively trading and picking individual stocks in the index,” Croak states.
You don’t have to be a savvy investor to make money with a passive portfolio management strategy. Many indexes have performed well over the years and have built-in protections to keep out less promising companies.
For instance, a stock can only be included in the S&P 500 if it has a $12.7 billion market cap and positive earnings in the most recent quarter and year. An equity must meet additional requirements to be included in the S&P 500. Stocks get added and removed from indexes to filter out less desirable picks and bring good assets into the index.
However, this approach will not let you outperform the market. Not every investor cares about exceeding market returns, but it is important to keep that in mind before committing to this approach.
“The return is essentially the market return minus any fees, Naghibi says. “Even scarier still is that passive portfolios will mirror the market’s declines without strategies to minimize losses, unlike active management, which can potentially navigate through downturns more adeptly.”
Discretionary Portfolio Management
Investors with discretionary portfolio management hire a fund manager and let that person make all of the decisions. This approach is similar to investing in an actively managed fund. However, you don’t get to see your portfolio too often, and it’s essential to find a fund manager whom you can trust.
Investors can check in with the fund manager, however, and it is common for fund managers to provide updates. However, a discretionary portfolio manager gets to act autonomously for the most part.
“While clients are kept informed about what the fund manager is doing with their portfolio, the final decisions are made by the fund manager,” Croak explains.
Non-Discretionary Portfolio Management
This structure also involves a fund manager. However, the fund manager acts as a mentor and offers suggestions instead of making decisions for the client.
You will have more oversight of your portfolio, but you are also responsible for its performance. Investors will have to conduct research, monitor their assets and stay on top of market news instead of relying on a fund manager to do it for them.
“The fund manager can give advice on the best actions to take, but the ultimate choice is up to the client,” Croak states.
[READ: 10 Things Your Financial Advisor Should Not Tell You]
Examples of Portfolio Management
Portfolio management offers plenty of variability within the four categories. Good portfolio management starts with understanding yourself and your objectives. Not every investor wants to take on a lot of risk, and some cannot withstand the inevitable volatility that comes with growth stocks. While some investors want to pick less risky investments, others want to put themselves in the best position possible to outperform the market, even with the risks involved. Here are some scenarios that would require different approaches:
Retired Investor With a Low-Risk Strategy
A retired investor who has a large nest egg probably won’t want to take many risks. This investor may invest in blue-chip dividend stocks and bonds for steady cash flow. This strategy involves living off of the cash flow that the assets generate.
Aggressive Investor Looking to Beat the Market
An investor looking to outperform the market will opt for an actively managed portfolio. The investor will either do their own research and make strategic picks or put their capital into an actively managed fund. The fund will have higher fees since there are more hours and research involved in making the fund a success.
Long-Term Investor Seeking Convenience, Reliability
Long-term investors who don’t want to stay on top of the stock market may opt for a passive investing strategy. These investors may pick low-cost funds that mirror an index like the S&P 500. This strategy has produced solid returns over the years, and some investors prefer a degree of certainty instead of the risks that come from trying to beat the market.
Investor Looking for Strong Professional Guidance
Individuals who want guidance may opt for discretionary or non-discretionary portfolio management. People who don’t want to look at their portfolios or make any decisions may opt for a discretionary portfolio. Non-discretionary portfolio management can help an investor who wants guidance while maintaining enough control to make the final decisions.
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Portfolio Management: Meaning, Types, Examples originally appeared on usnews.com
