PORTFOLIO MANAGEMENT

What Does Portfolio Management Mean?

The art and science of making decisions about investment mix and policy, matching investments to objectives, asset allocation for individuals and institutions, and balancing risk against performance.

Portfolio management is all about strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other tradeoffs encountered in the attempt to maximize return at a given appetite for risk.

If you own more than one security, you have an investment portfolio. You build the portfolio by buying additional stocks, bonds, mutual funds, or other investments. Your goal is to increase the portfolio's value by selecting investments that you believe will go up in price.

According to modern portfolio theory, you can reduce your investment risk by creating a diversified portfolio that includes enough different types, or classes, of securities so that at least some of them may produce strong returns in any economic climate. Every practical discipline is based on a collection of fundamental concepts that people have identified and proven (and sometimes refined or discarded) through continuous application. These concepts are useful until they become obsolete, supplanted by newer and more effective ideas. Portfolio management is like bridge-building, a discipline, and a number of authors and practitioners have documented fundamental ideas about its exercise.

• A portfolio contains many investment vehicles.

• Owning a portfolio involves making choices -- that is, deciding what additional stocks, bonds, or other financial instruments to buy; when to buy; what and when to sell; and so forth. Making such decisions is a form of management.

• The management of a portfolio is goal-driven. For an investment portfolio, the specific goal is to increase the value.

• Managing a portfolio involves inherent risks.

What is diversification and why is it important?

If you invest in a single security, your return will depend solely on that security; if that security flops, your entire return will be severely affected. Clearly, held by itself, the single security is highly risky.

If you add nine other unrelated securities to that single security portfolio, the possible outcome changes; if that security flops, your entire return won't be as badly hurt. By diversifying your investments, you have substantially reduced the risk of the single security. However, that security's return will be the same whether held in isolation or in a portfolio.

Diversification substantially reduces your risk with little impact on potential returns. The key involves investing in categories or securities that are dissimilar: Their returns are affected by different factors and they face different kinds of risks.

Diversification should occur at all levels of investing. Diversification among the major asset categories—stocks, fixed-income and money market investments—can help reduce market risk, inflation risk and liquidity risk, since these categories are affected by different market and economic factors.

Diversification within the major asset categories—for instance, among the various kinds of stocks (international or domestic, for instance) or fixed-income products—can help further reduce market and inflation risk.

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