by 5paisa Research Team Last Updated: 2022-09-30T13:05:12+05:30

Introduction

The financial markets offer a host of different products and instruments. A portfolio is a basket of financial assets held by an individual, investment firm, or financial institution. The general notion is that portfolios include stocks, bonds, mutual funds, derivates, and cash equivalents. However, the definition of a portfolio is wider and includes real estate, private investments, gold, and even art.  

You may choose to hold and manage a portfolio based on your comfort and knowledge of the investment markets. Alternatively, you may hire a professional advisor or money manager to handle the portfolio on your behalf.

 

Key Takeaways

The primary factors affecting the financial decisions of an investor include risk appetite, the time horizon of investment, and financial goals. 

It is pertinent to understand the meaning of a portfolio, factors affecting an investment portfolio, types of portfolios, ideal asset allocation, and the need for portfolio management services to build a profitable portfolio. Let's discuss each of these in detail below.

 

What is a Portfolio?

A portfolio meaning in finance is a collection of assets that can grow in value and provide returns. Portfolio management's premise is diversification and not putting all your eggs in one basket. Diversification reduces risk by investing in various instruments, categories, and industries. The objective is to invest in different areas that react differently to the same event leading to maximum profit generation.

While there may be many ways for diversification, you must choose how to do it. Your risk appetite, investment period, future goals, and personality affect how you grow your portfolio. Irrespective of your portfolio's asset mix, all portfolios must contain some degree of diversification and reflect an investor's tolerance for risk. Other important restrictions include liquidity requirements, tax implications, legal situations, and other unique circumstances. 

You may visualize a portfolio as a pie divided into pieces of different wedge-shaped sizes. Each piece represents a unique type of investment or asset class. Stocks, bonds, and cash are the core building blocks of a portfolio. Real estate, art, and collectables are niche products that may help grow the portfolio. 

Portfolio management is vital to maximizing returns. It refers to investing in the most profitable assets based on your risk tolerance and financial objectives. Portfolio management is not a one-time action and does not end with portfolio creation. It is dynamic, and you must constantly monitor your portfolio. The objective is to ensure that each asset class earns the maximum returns within a time frame. Frequent portfolio review allows you to liquidate your investment and channel the funds into a more lucrative alternative. 

 

Need for Portfolio Management

With comprehensive portfolio management, you can build a suitable investment plan aligned with your income, financial goals, age, and risk appetite. The need for active portfolio management is as below:

 ●    The regular review helps to safeguard against investment-oriented risk and maximizes the profit potential. 

●       It enables you to develop sound investment strategies and rebalance the asset class mix based on the current market conditions for maximum benefit for existing investments. 

●        It allows quick customization based on immediate financial needs and market conditions. 

●        Portfolio diversification allows investors to manage risks and generate improved returns. 

●        Lastly, it helps you analyze investments that work best under a certain market situation and allows you to distribute resources into different asset classes. 

Those investors who do not actively track financial markets or lack the foresight to manage a portfolio reach out to professionals. 

 

Factors to consider when creating a portfolio

1. Diversification

The primary objective of a portfolio is diversification to protect yourself from the downturn. Diversification includes investing in various asset classes and different categories within an asset class. 

For example, a good approach is to distribute your investment into various market categories if you invest in the stock market. You may invest in industries or companies with different market capitalizations or the index to limit the overall risk exposure. 

2. Investment Cost

For investors, expenses such as management fees and commissions directly impact profitability. It is especially relevant if you invest regularly and in different asset classes. Therefore, it may be beneficial to switch to a discount broker. These firms charge significantly lower fees. 

Additionally, it is best not to make decisions based on short-term market changes and adhere to your long-term goals. Avoid reacting to short-term dips in investments. 

3. Frequent Investment

Regular investments help to strengthen your portfolio and increase your wealth over a long period. Also, it teaches a habit of savings and avoids frivolous expenses. As your income level rises, you may also increase your investment amount. 

4. Follow-Up Strategy

Investors often use the follow-up strategy in case of performance uncertainty. A follow-up strategy involves trivial initial investments. You increase the investment corpus if the investment meets your performance expectations.

Therefore, the follow-up strategy avoids simultaneously committing a significant chunk of your portfolio to one investment. The idea is to increase your investment in a staggered manner over time. 

 

What are the Types of Portfolios?

Based on the type of investment strategy, one may bifurcate portfolios as below: 

Income Portfolio: The income portfolio focuses on generating regular income from investments rather than capital appreciation. For instance, income-driven investors may choose to invest in high dividend-yielding stocks. 

Growth Portfolio: The growth portfolio aims at investment avenues in an active growth stage. Typically, growth portfolios entail high risk and reward aspects. 

Value Portfolio: A value portfolio concentrates on deriving maximum value for investors. It commits to assets with lower valuation and intends to secure bargains in the investment market. Value investors seek profitable companies with share prices lower than their fair value. 

Aggressive and Defensive Portfolio: A portfolio may be aggressive or defensive based on the risk involved. Aggressive portfolios have high beta and experience higher price fluctuations. Conversely, defensive portfolios strive to reduce the risk of capital erosion.

Factors that Affect Portfolio Allocation

Various factors affect portfolio allocation – especially risk tolerance and time horizon. 

The time frame of investment is important to build a profitable portfolio. The general rule suggests that you should rebalance your portfolio to achieve a conservative asset allocation mix once you approach closer to your financial goals. It prevents erosion of accumulated earnings of an investment portfolio. Similarly, investors nearing retirement must invest a significantly in less risky assets, whereas novice investors may choose aggressive instruments. 

Secondly, risk appetite impacts asset allocation. The cumulative risk associated with each asset class must not breach the risk threshold of the investors. The risk involved for each investment type is different, and an investor must choose wisely. 

In conclusion, a portfolio is a cornerstone to investing, and each component must work together to meet your financial goals.

 

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Frequently Asked Questions

Portfolio creation starts with identifying your goals, risk tolerance, and time horizon. Next, research and select investment opportunities that meet your requirements. Regularly monitor and update your portfolio and its performance. Lastly, rebalance your portfolio as per your immediate financial needs.

Based on the investment strategy, the types of portfolios include Income Portfolio, Growth Portfolio, Value Portfolio, and Aggressive and Defensive Portfolio.