Basics of Portfolio Management
I want to layout the basics of portfolio management and risk. Everything a portfolio manager does; planning, asset allocation, diversification, risk management, investing strategies, etc., boils down to trying to affect investment risk and return. This is why it is critical to understand portfolio management and risk; and how it relates to investment returns.
This week’s investment series on Risk and Return include these posts:
Portfolio Management and Risk
Successful portfolio management involves making prudent decisions based on probabilities. Better than average returns can be obtained by understanding the probabilities and types of investment risks, and using portfolio management tools to measure and mitigate the risks.
Here are some examples of concepts we will address this week:
Asset Allocation – is the most important concept in investment management because it determines 90% of portfolio returns. Spreading your assets among different categories reduces volatility risk of a portfolio. Asset allocation is all about investment risk and returns.
Diversification – is about reducing specific risk. Proper diversification is the only free ride in investing. If you invest in one stock you are gambling on the probability that one asset will do well. By investing in several or many companies and industries the investment risk of the whole portfolio is reduced.
Valuation – If you invest in an asset that has a high valuation the probability is your return will be less than if you invest when the valuation is low. Risk can be mitigated by considering valuation before making an investment.
Planning – How much you need to save for your retirement is based on probabilities of risk and return. How much you withdraw from your investment portfolio during retirement is based on the probability of running out of money in your lifetime.
Portfolio Management Requires Risk Management
Investment risk is one of the most important concepts for the portfolio manager to understand and master. Portfolio management requires management of investment risk. Asset allocation, diversification, valuation, and investment planning require analysis of various risks and solutions. In the above four posts we will examine investment risk and returns and how they relate to successful portfolio management.
Related Reading: Risk