One of the more opaque phrases thrown around in financial services is “portfolio management.” Although it might seem like a simple enough concept, those two words can act as a stand-in for anything from the assets you’ve invested in, to your overall strategy, all the way down to the people, products or algorithms that dictate the “where, when and why” of your financial holdings.
Do you prefer growth or value? What’s your time horizon? How have you rebalanced recently? Have you shifted equities to fixed income? Is your mutual fund actively managed or rules-based or a mix of both? What’s your international exposure? Each of these questions touches on one or several aspects of portfolio management.
In this piece, we’ll break down the principles and tackle the assumptions that are at the heart of portfolio management. More importantly, this article should help you determine how portfolio management best suits your own investment needs and allow you to wade into your finances with confidence.
Should you care?
First of all, let’s establish what we mean by “portfolio management” and “rebalancing.” Portfolio management is the act of actively managing your investments to achieve a certain return potential or stick to a specific strategy. Essentially it’s the constant intelligent management of your assets.
Rebalancing meanwhile, is a periodical reassessment of the weightings that each investment has in your portfolio. It’s meant mostly to make sure your portfolio, as is, doesn’t stray too far from how you intended when you originally made your investments.
Think of portfolio management like a proactive technique, and rebalancing like a reactive technique.
Before getting into the principles that underlie portfolio management, the most important thing for investors to understand how much they should intervene in their portfolio.
For most, it’s neither practical nor necessary to meddle in their investment accounts more than a handful of times a year. Not only does overmanagement incur greater transaction and redemption fees from any brokerage or mutual funds you invest with, but reactionary investing emphasizes short-term market conditions over long-term results, which can undermine the whole point of investing.
Still, that doesn’t mean that you should be regularly apprised of how your money is allocated, even if you invest in passively managed funds. Changes in your personal life and the economy could require you to tweak your investments to align with years-long economic cycles. There’s very little that can happen in a day on the stock market that would require you to call your broker on the spot, but keeping a regular appointment schedule shouldn’t be a privilege exclusive to your dentist.
Portfolio Management: Optimization to achieve your Portfolio Goals
At the heart of portfolio management is your asset allocation, or the breakdown of the equities, commodities, debt or whatever other investments that make up your portfolio. This allocation, and how it changes, should serve as the starting and ending point for any portfolio-related questions.
Every investment vehicle has its own profile that determines its behavior and risk under a variety of circumstances. Most long-term investors have a portfolio made up of a strategically curated assortment of different assets that work together to maximize returns and/or minimize risk, depending on their objectives.
For example, a 30-year-old saving for retirement might have a riskier but higher-performing asset allocation, meaning more equities, than someone nearing 60. The idea behind this is that a 30-year-old has more time before they really need the money, so they can afford to take more risk in the name of outperformance.
The point is that the assets that make up your portfolio should work in coordination with each other to always meet your goals. That might entail putting more toward high risk/high reward investments, or maybe emphasizing income-generating investments, or relying on a mutual fund to help you outperform the broad market. When they are portioned out according to your objectives and risk profile, your portfolio is considered balanced.
Rebalancing: Maintaining balance in your Portfolio
For example, let’s say you have an asset allocation of 20% individual stocks, 40% index funds, and 40% bonds. Over time, those assets might expand or contract based on how each one performs relative to the others, making you overweight in some areas or underweight in others. This can throw that investment itinerary out of whack.
When this happens, investors re-allocate their assets to match their original proportions. This, as you might expect, is called rebalancing, and most serious investors do it at least annually.
As straightforward as it might sound, doing an annual rebalancing can also be a time to reassess your investment needs. This might mean shifting your portfolio’s focus to other areas of the market that you or your investment advisor might see greater potential in achieving your objectives.
Performing a regular rebalancing can also help you to adapt to new economic conditions. However, delving into the shifting economic tides is a different, more proactive and tactical area of portfolio management.
The importance of the Investment Cycle
You may have learned in Econ 101 that free market economies generally oscillate between peaks and valleys on a fairly regular basis; boom and bust; growth and recession. It’s in these gradual shifts that a portfolio can become unbalanced or simply no longer be optimized to meet the investor’s goals.
As mentioned, different investment vehicles perform in different ways under different economic circumstances. Stocks and equity investments do well in a growth period, while bonds do better in recessionary periods. Banks tend to do well in a rising interest rate environment, while commodities do better when inflation is down and the dollar is weaker.
Some investors have recognized these patterns and have formulated an investment cycle to maximize returns and minimize loss when the economy shifts from one phase to the next. Shifting your investments by 5-10% according to this cycle is called Tactical Asset Allocation, and it can act as a supplement to your overall portfolio that generates some added revenue.
Tactical asset allocation is a more advanced investment principle and is generally a short- or medium-term strategy. While tailoring your portfolio to capture the most upside in a particular market environment sounds ideal, it also requires closer investor scrutiny to avoid overexposure should circumstances in the market change. Investors should keep their overall objectives in sight when deciding how to go about weighting their portfolio.
Why you should care
As was hopefully conveyed throughout this piece, the potpourri of portfolio management all centers on best achieving your financial goals. And what those goals are will determine how often you should be proactive in actively managing your portfolio, or be reactive and do a rebalancing of your assets. Or maybe both.
Your ambitions will change over time due to a variety of unknowns, but taking regular stock of your investment assets will allow you to adapt to the unforeseen, and ultimately serve you for whatever life has in store.