Just as a seasoned captain navigates his ship through turbulent seas, a wise investor needs to steer his portfolio through volatile financial markets. Portfolio management is the process of overseeing and directing a group of investments to meet financial objectives. There are myriad ways a portfolio can be managed using active, passive and factor-based styles, all of which can be implemented using aggressive, conservative or balanced strategies. If you need help managing your investment portfolio, consider working with a financial advisor.
What Is Portfolio Management?
At its core, portfolio management is the process of selecting and managing an investment policy that minimizes an investor’s risk and maximizes their return on investment. It involves a delicate balancing act of mitigating risk and improving performance so investors can achieve their financial goals. The importance of portfolio management lies in its ability to provide a structured strategy for decision-making, enabling investors to control risks while striving for consistent returns.
Here are three of the most common investment styles.
Active Portfolio Management
Active portfolio management involves a hands-on approach where the portfolio manager, often a financial advisor, continuously monitors and adjusts the portfolio to outperform a general stock market index such as the S&P 500. It requires high involvement and expertise due to the need for close attention to the market and making appropriate adjustments to the client’s portfolio. However, active management often costs more than its more passive counterpart.
A notable example of active portfolio management is the Fidelity Contrafund, one of the largest actively managed mutual funds with over $107 billion in assets as of June 2023. Since its inception in 1967, the fund has outperformed the S&P 500 index by an average of over 2% per year.
Passive Portfolio Management
Unlike active management, passive portfolio management is a low-cost, hands-off strategy that does not involve regular buying and selling of securities. Rather than outperform a specific index or the market as a whole, passive investments simply look to mirror the returns of a particular index. This cheap yet effective method appeals to cost-efficient users.
A shining example of this management approach is the Vanguard 500 Index Fund, a passively managed fund that has closely followed the performance of the S&P 500 index, providing an average annual return of around 11% per year since it launched in 1975.
Factor-based Investment Management
Factor-based investment management involves selecting securities based on attributes or “factors” that are associated with higher returns. These factors can range from company size and value to stock price momentum and more. The iShares MSCI USA Momentum Factor ETF, a factor-based fund, focuses on large- and mid-cap stocks with high price momentum.
Types of Portfolio Management Strategies
Portfolio management strategies vary drastically, contingent on the investor’s financial goals, risk tolerance and investment horizon. Depending on those variables, investors can build their portfolios by pairing the following strategies with the aforementioned management styles.
Aggressive Investing
Aggressive investing involves taking on higher risk for the potential of higher returns. Take the case of Amazon’s aggressive investment in technology and expansion — it is not a guarantee, but it has yielded a substantial return since its initial public offering (IPO) in 1997. It’s important to understand that high returns are not a guarantee with all aggressive investments.
Defensive Investing
On the other hand, defensive investing focuses on steady growth while mitigating risk. The Coca-Cola Company, known for its defensive investing strategy, has seen stable growth rates and consistently paid out dividends for over 50 years. Meanwhile, whole sectors like healthcare and utilities are also seen as defensive investments, since the consumer demand for both stays consistent through different market cycles. However, it’s key to remember that this doesn’t imply that defensive investing always results in steady growth.
Balanced Investing
Balanced investing is a blend of both aggressive and defensive strategies. It aims to strike a balance between risk and reward. Apple’s balanced investment strategy, which involves both innovative progress (aggressive) and maintaining a solid cash reserve (defensive), has seen it become one of the most valuable companies globally. As of July 2023 it had a market capitalization of more than $3 trillion. However, balancing risk and reward does not always guarantee success as it depends on numerous external and internal factors.
Benefits of Proper Portfolio Management
Proper portfolio management, orchestrated with the guidance of a financial advisor, can potentially offer several rewards.
Maximizing ROI
Effective portfolio management strives to maximize the return on investments (ROI). A well-managed portfolio could have transformed a $10,000 investment in the S&P 500 in 1980 into nearly $1 million by 2020.
Responding to Disruptions Quickly and Effectively
Portfolio managers who quickly shifted investments away from travel and hospitality stocks during the COVID-19 pandemic were able to mitigate losses, thereby highlighting the importance of agility and expert advice in portfolio management.
Faster Time to Market
Early investment in promising companies can lead to substantial gains. But investing early in promising companies also involves uncertainties and potential risks. Portfolio managers who invested early in Tesla were able to capitalize on the company’s rapid growth.
Better Strategy-Execution Alignment
Portfolio management can facilitate better alignment between an investor’s strategic objectives and how they’re executed. For example, an investor who is decades away from retirement is likely better suited with an aggressive growth-oriented portfolio while someone who is just a few years away from retiring is better served by more conservative investments.
What Does an Investment Portfolio Manager Do?
An investment portfolio manager is responsible for making investment decisions, managing risks and ensuring that the portfolio aligns with the investor’s objectives. In searching for a portfolio manager, look for a financial advisor with a strong track record, clear communication and a strategy that aligns with your risk tolerance, timeline and investment goals.
Bottom Line
Choosing the right portfolio management strategy is a critical step toward accomplishing your financial goals. It requires grasping your financial objectives, risk tolerance and the current market conditions. Remember: successful investment is not a one-size-fits-all endeavor – it requires a strategy uniquely tailored to suit your personal circumstances. There are different styles of management, including active and passive styles, as well as different types of investment management, including aggressive, defensive and balanced approaches.
Tips for Managing Your Portfolio
- A financial advisor can help you manage your portfolio to meet specific financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Finding an appropriate mix of stocks, bonds and cash is key. SmartAsset’s asset allocation calculator can help you select the right combination of assets based on your risk tolerance and objectives.
Photo credit: ©iStock.com/damircudic, ©iStock.com/courtneyk, ©iStock.com/PeopleImages