Most investors leave the more technical aspects of portfolio management to their financial consultants. However, this need not be the case. The average educated person can certainly gain a grasp of the topic sufficient enough to help make his or her own investment decisions. The key to learning is gaining the knowledge and then practice applying it to your own portfolio in small amounts until you feel confident enough to manage it completely on your own. Here, we will briefly describe some of the concepts behind portfolio theory as well as some general techniques applied by portfolio managers. There are many good books that can give more in depth information if you feel this is something you would like to know more about.
Main Portfolio Decisions
The first important facet of portfolio management is understanding the two main decisions, which are related but completely separate for purposes of practicality. These two decisions are
1) Broad-based asset allocation and
2) Specific security selection
The most important thing an investor can do is go through the in-depth process of determining a portfolio asset mix at the very onset of each year and again anytime there is a significant change to their portfolio. It is only after this mix is determined that the process of choosing individual investments should be made.
Asset classes are by far a bigger factor in overall performance than individual security selection as time invested increases. Or to put this in a more pragmatic way, it doesn’t matter in a 10-year period of time which stock you chose as much as it matters that you chose stock. This doesn’t mean an individual security can’t make a difference. It just means that it becomes less important over a period of five years or so since all securities of a given class tend to move toward an average performance which balances out extreme movements in specific periods of time.
Another important facet of portfolio management is that one makes analytical decisions and not make decisions based on hunches or emotion. This kind of pragmatic and analytical approach will keep the average investor from making decisions to move money completely in or out of a security or an asset class based upon the latest market rumors or the five o’clock news. Regardless of what insight we feel inclined to follow, the numbers and the data of past performance gives us clear indications that moving in and out of asset classes or individual securities during adverse periods hurts more than it helps in the long run. And if a decision is made to divest out of a specific security, it is always advised to dollar-cost average out of the investment in the same manner that one should have dollar-cost averaged “in”.
Dollar cost averaging is a technique by which an investor divides the given investment over a period of time and invests that amount on a regular basis as opposed to buying in all at once. This technique is covered in more detail in a previous article.
The simple concepts above can help you to begin making decisions like a professional. Of course there are many other aspects of portfolio management that go in depth into both of the above investment decisions. Look for those more detailed articles in our investing learning section.
Information is for educational and informational purposes only and is not be interpreted as financial advice. This does not represent a recommendation to buy, sell, or hold any security. Please consult your financial advisor.
