Portfolio ManagementConsumer Products
What Is Portfolio Management?
The idea of managing your own investments can feel daunting, but no matter how much money you have, there is a level of portfolio management right for you.
If you’re just starting out, you can explore index funds, or even automated portfolios if you don’t want to manage your own portfolio. If you have a more complicated financial picture, a financial advisor or wealth advisor may be more your speed.
What is a portfolio?
A portfolio is a person’s or institution’s entire collection of financial assets. This can include stocks, bonds, mutual funds, real estate, cryptocurrency, art and other collectibles. A “portfolio” refers to all of your investments — which may not necessarily be housed in one single account.
Portfolio management definition
Portfolio management is a cohesive investing strategy based on your goals, timeline and risk tolerance. Portfolio management involves picking investments such as stocks, bonds and funds and monitoring those investments over time. Portfolio management can be done on your own, with a professional or through an automated service.
Portfolio management: Key takeaways
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Portfolio management can range in price: Some services are completely free while others charge 1% of your assets under management or more.
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There are two main portfolio management strategies: active management and passive management.
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Portfolio management involves concepts such as asset location, diversification, rebalancing and tax minimization.
Active vs. passive portfolio management
Two main portfolio management strategies are active and passive management.
Active portfolio management: Active portfolio managers take a hands-on approach when making investment decisions. They charge investors a percentage of the assets they manage for you. Their goal is to outperform an investment benchmark (or stock market index). However, investment returns are hurt by high portfolio management fees — clients pay 1% of their balance or more per year to cover advisory fees, which is why more affordable passive portfolio management services have become popular.
Passive portfolio management: Passive portfolio management involves choosing a group of investments that track a broad stock market index. The goal is to mirror the returns of the market (or a specific portion of it) over time.
Like traditional portfolio managers, a robo-advisor — a service that uses a computer algorithm to choose and manage your investments for you — allows you to set your parameters (your goals, time horizon and risk tolerance). Robo-advisors typically charge a percentage of assets managed, but because there is little need for active hands-on investment management, that cost is a fraction of a percent in management fees (generally between 0.25% and 0.50%).
If you want more comprehensive help — investment account management, plus financial-planning advice — consider using a service such as Facet Wealth or Personal Capital. These services combine low-cost, automated portfolio management with the type of financial advice you’d get at a traditional financial planning firm — advisors provide guidance on spending, saving, investing and protecting your finances. The main difference is the meetings with your financial planner take place via phone or video instead of in person.
Portfolio management: Things to keep in mind
Portfolio management isn’t solely about building and managing an investment portfolio. Here are some concepts that can help you choose your investments and manage them wisely.
Asset location answers one question: Where are your investments going to live? The type of account you pick will become your investments’ home — and there are lots to choose from. The key is to pick the best type of investment account for your goals.
Part of picking an investment account is choosing between taxable accounts and tax-advantaged ones. This decision can have both short-term and long-term tax implications. You’ll want to be sure to use designated retirement accounts such as IRAs and 401(k)s for your retirement savings, because these offer tax advantages — for example, money you contribute to a Roth IRA grows tax-free. You may also want to have a standard taxable investment account to invest for non-retirement goals (such as saving for a down payment).
Asset allocation looks similar to asset location, but it refers to how your portfolio is divided up between different types of investments. This is usually related to your level of risk tolerance. For instance, if you have many years to go before you retire, you have more time to take risk, and so you can have a larger portion of your portfolio in riskier investments. If you’re closer to retirement, you may want to have an asset allocation with a larger proportion of less risky investments.
Diversification refers to spreading your investing dollars across different companies, geographies, sizes and industries. That way, if one particular industry sinks, your whole portfolio does not. For instance, investing in funds, which are essentially baskets of lots of different securities, provides more diversification than investing in a single stock.
Rebalancing is how portfolio managers maintain equilibrium within their accounts. Portfolio managers do this to stay true to the target allocation, or what percentage of the portfolio is in more risky investments versus less risky investments, originally set for the investment strategy. Over time, market fluctuations might cause a portfolio to get off course from its original goals.
Tax minimization is the process of figuring out how to pay less overall in taxes. These strategies work to offset or lower an investor’s exposure to current and future taxes, which can make or break an investor’s returns. It’s important to consider tax-efficient investing to avoid pricey surprises from the IRS.
Putting it all together
Portfolio management in the real world combines all of these aspects into one personalized portfolio. Say an investor is planning on retiring in five years and doesn’t want to take much risk. They have a 401(k) from their employer (their asset location) where they put a portion of their paycheck. Their asset allocation could be 50% stocks and 50% bonds. If this ratio changes over time, and the investor winds up with a portfolio closer to 55% in stocks, that gives them a riskier portfolio than they are comfortable with. The investor or a portfolio manager would then rebalance the portfolio to bring it back to its original 50/50 ratio.
Tax minimization can go hand and hand with asset location. For example, if you choose to locate your assets in a Roth IRA, you are inherently minimizing your taxes since qualified Roth distributions are tax-free in retirement.
Portfolio management decisions are guided by four main factors: an investor’s goals, how much help they want (if any), timeline and risk tolerance.
1. Setting goals: Your savings goals — retirement, a home renovation, a child’s education or family vacation — determine how much money you need to save and what investing strategy and account type is most appropriate to achieve your objectives.
2. Figuring out how much help you want: Some investors may prefer to choose all their investments themselves; others would be more than happy to let a portfolio manager take over. If you can’t decide, a robo-advisor might be an ideal solution, as these services are very low cost. Portfolio managers will charge more than a robo-advisor, but they typically offer a customized portfolio and other services beyond portfolio management, such as financial planning.
3. Mapping out your timeline: When do you need the money you’re investing, and is that date set in stone or flexible? Your timeline helps inform how aggressive or conservative your investing strategy needs to be. Most investment goals can be mapped to short-, intermediate- and long-term time horizons, loosely defined as three years, three to 10 years and 10 or more years. If, for example, you need the money within three years, you’ll want to minimize your exposure to the short-term volatility of the stock market.
4. Determining your tolerance for risk: An investor’s willingness to accept risk is another key driver behind diversification decisions. The more risk you’re willing to take, the higher the potential payoff — high-risk investments tend to earn higher returns over time, but may experience more short-term volatility. The goal is to strike the right risk-reward balance, picking investments that will help you achieve your goals but not keep you up at night with worry.
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