Portfolio Management

There are many reasons for investing. Some investors do it for a living while others pursue it as a hobby. Some invest for a quick return while others look for long term benefit. All investors large and small engage in some type of portfolio management. Portfolio management is how an investor decides what to do with the collection of investments under the investor's control. The management of an investment portfolio is driven by the skill and knowledge of the investor, the opportunities available to that investor, the goals of the investor and the investor's response to economic activity and investment performance. There are a number of strategies an investor may use to manage a portfolio and a number of tasks to maximize portfolio management. All of this starts with goals and continues with investor education. Although many portfolio managers and investment advisors are available, the individual investor must exert control over how investments are managed. Adjustments to a portfolio may take place because of changing objectives or may depend on where the investor is in his or her life cycle. Risk also determines what moves an investor will make. Often, investors close to retirement will look to build portfolios and limit risk.

Keywords Asset Allocation; Diversification; Investment Objective: What the investor hopes to gain by investing.; Portfolio; Portfolio Management; Risk averse; Risk

Overview

When we think of a portfolio we think of a folder or collection of related items. If you are an artist, you might have a portfolio or collection of your works of art. Many professionals in many fields create portfolios that represent who and what they are and what they can do. Professional portfolios can be useful for professionals whether they are teachers, graphic artists, speakers, managers, technology professionals and so on. A financial portfolio is the collection of financial investments and in essence the financial position or situation for an individual or a company. This means that you include liquid assets like cash as well as real estate, stocks and bonds, 401K plans and insurance. Your portfolio considerations also include credit liabilities and can impact your ability to acquire new investments.

Companies may also have cash or real estate or stock as investments. However, they may often have different goals than individuals. Instead of personal security, companies may have objectives based on the company stakeholders. Another difference between individuals and companies is that a company may be able to afford a team of specialists who analyze investment options and performance. Individuals may have a professional financial advisor or may simply do the best they can on their own. An investment company is one that will manage the funds of investors based on the investor's objectives for a fee to manage the funds.

Activities Included in Portfolio Management

Managing your portfolio includes deciding what is in the portfolio, what to keep, what to acquire next and how to leverage what you have to get other investments. A simple portfolio decision for an individual might involve changing the asset allocation in a 401K plan, to move away from investment in international stocks to other investments, based on the performance of the investment and how much risk the investor is willing to allow. Joshi (2007) quoted a financial planner who felt that many people just follow what they see or hear instead of having a goal they can stick to and pursue relentlessly. Without a specific goal and strategy, individual investors may be frightened or wiped out by any crisis situation. A crisis may signal a need for a change in strategy but not necessarily a move away from objectives. Sticking to a goal requires patience and if you don't know why you are investing, it will be difficult to achieve your goals with the ups and downs in the marketplace.

Many investment plans offered to employees regularly provide information to the individual investor as to what the performance is of certain investments and may even include a 'sure thing' fund that may have a guaranteed performance level. These funds have a lower rate of return but typically less risk. Smaller, individual investors may prefer these funds because it is less likely that they will lose money on the investment. In addition, if someone is expecting to work for a period of years for one employer at a specific income-level, that individual can almost predict what amount of money the investment will grow to over time.

Small Investor Pitfalls

There can be pitfalls related to the patience of the small investor. Joshi (p. 149 - 150) interviewed a financial consultant who noted that the small investor is often not looking at the investment for the long term such as a period of 5 — 10 — 20 years. Also, the small investor may have unrealistic expectations as to where the investment may grow over time. It is unlikely that a stock that has performed a certain way and yielded a certain percentage of income over the last 10 years will dramatically increase that income unless specific, unforeseen world changes occur. Dramatic changes also don't continue forever. The small investor may also want to use a strategy called diversification where the investments are balanced in such a way to limit the risk of the investors. If you invest too much in one thing, the entire investment is jeopardized if the single investment plummets. This can be disastrous to most average workers who spend an entire lifetime working to support themselves and their families in the hopes of living comfortably in old age. For example, the workers at Enron, who had money invested in Enron stock, saw their lives change dramatically after the collapse of the company. As the stock rose, employees nearing retirement could dream of possibly retiring early, paying off debts and investing in items they may have always wanted.

Unreliability of Portfolio Management

Portfolio management can be described as both art and science because while experience is helpful in determining what makes a good investment, there are incidents and situations that cannot be anticipated. War, natural disasters, inflation, new inventions, company failures, industry changes and rumors can all impact the value of an investment. What constituted a perfect investment at one point might be a terrible investment at another time. For example, one part of the country may be an excellent investment for real estate. The land may be cheap and resold at a higher cost. The community may be a desirable one to live in. However, after the prices rise past a certain point, the investment may not make sense because the resale value may be lower. Improvements in the community such as highways and airports may cause additional congestion which may make it less desirable to live in and more difficult to sell.

Ownership & Decision-Making

Portfolio management is a difficult task for the average individual investor because the investor may not possess a solid foundation of financial skill and education. Often financial advisors are simply people trying to make a living at advising others in the area of finance and may not possess a high level of skill in investing. The individual advisor doesn't necessarily have access to the best financial minds. Even with a financial advisor at your side, no matter how good, the buck stops at the desk of the investor.

In addition to seeking professional help, the investor must also become a student of finance and understand how investments work. This is a distasteful task for some and simply boring for others. The earlier in life that an individual learns about finance, managing money and investing, the more likely it is that the individual will take ownership in investing. Besides ownership and initiative, the investor must be able to make decisions. These decisions should be driven by a sound set of financial objectives. The investor should have some reason for investing and be able to ask the right questions to determine what outcomes are desired from investing.

Investment Considerations

Some life situations may drive an investor's desire to invest. If the individual has witnessed difficult situations in their families due to loss of employment, illness or other situation, they may be very motivated to plan for the care of their families and themselves in old age. Benzoni, Collin-Dufresne, & Goldstein (2007) explored the connection between the investor's age and the makeup of the investor's portfolio. Investors have to consider their age and the amount of time they have to invest because investing is a long term activity and assets only provide real return over the long haul. When individuals become parents they may have a desire to provide for the care and education of children and feel investing allows them to plan and take control of the future financially.

Cane (2007) found the complications in the job of the financial advisor when the investment portfolio objective included caring for a family member with a disability. This is especially true if the disabled member is a child since the parents may not live long enough to personally manage the financial affairs of a child. In these cases, the considerations may go beyond financial considerations and include caretakers who will manage the financial affairs of the disabled individual. A disabled child may not be able to handle finances and make decisions even at an adult age if the disability is a mental one. Similarly, the disabled child may be unable to dispose of the affairs of the parents upon their death and may be unable to work to provide self support. Cane noted that trusts could be set up for a disabled person to provide income, supplemental needs trusts to provide for needs without counting as income and pooled supplemental trusts to provide for management of the trust portfolio even if it isn't big enough to interest a large manager. The key for disabled persons is to make sure that assets are not in their name. This action makes certain that the disabled person can still take advantage of services provided by the government for people with disabilities.

If someone is fortunate enough to have a good income, it may be desirable to invest a portion of that income in case the situation or economy changes. Some investments are rewards for people who spend most of their life working. Investments in a second or vacation home may provide investors with a goal to achieve or something that they can pay for and enjoy. A real estate investment may become a retirement home, be sold later for income, to pay for education or to upgrade a first home. High risk investments that allow high returns can provide a windfall for an investor to use for early retirement, travel or to spend on luxury items. Individuals who work on commission or receive bonus checks or overtime may look for ways to invest their extra earnings in order to avoid simply spending them.

Five Rules for Investing

Ownership and accountability means taking measured steps as it relates to managing your portfolio. Joshi (2007) offered "five golden rules of investing" including:

• Don't trade — too difficult for the average investor if you don't do it all the time.
• When thinking stocks, think long term — that's where stocks perform best.
• Diversify to avoid short term crises.
• Invest regularly and see investing as a long term activity.
• Set goals to achieve lifelong goals.

Balancing a Portfolio

Mannes suggested that people don't look at their portfolios often enough to realize how much they may have changed. Mannes recommended the following guidelines to balance a portfolio and keep it from getting out of control:

• Decide when to rebalance

• You can do it on a regular schedule such as annually or quarterly or
• You can decide to do it when the investment moves away from your initial target for it.
• Pick a trigger point that tells you when to move things around.
• Limit actions with tax consequences such as selling.
• Simplify it by using the tools that fund managers provide for making these decisions.

Sometimes the biggest problem that the small investor may encounter is that there are so many decisions, so many ways to make them and so much information available. It may lead to financial information overload or paralysis.

Asset Allocation

There are many investments an investor can select. These assets fall into classes. An asset class is a category of assets and can include stocks, bonds, real estate and foreign securities (Morgenson & Harvey). Asset allocation is a way to protect the investor from unforeseen actions and to prepare for the future. Uncertainty is a fact of life and asset allocation is a result of strategy, not a guarantee. Asset allocation is based on the fact that the investor has many options when deciding where, how and how much money to invest in specific investments.

Blankson (2005, p. 1) considered doing a good job of asset allocation as a way to build wealth and security and to ensure protection from single, disastrous events. Blankson (p.2) believes the small investor is very likely to avoid asset allocation. This could be due to the simplicity of not having to decide. It could be much easier to put all of your money in one bank or have all of your investment in your home. Blankson advises against the simple route citing natural and financial disasters of previous years as proof that putting your money in one place is dangerous.

As people become more computer literate and software becomes more user friendly, investors can more easily track their own investments. Many online finance sites and investment companies also have online tools for their customers to use. Asset allocation involves more that simply tracking the assets. The investor must also compare allocation opportunities and determine which course of action is best based on the information available, the risk involved and the investment objectives. The small investor will almost always have real estate as a part of the investment portfolio. Since a place to live is a requirement for most people, many will dream of owning and pursue owning a home. For many investors, this may be the largest investment they will make in a lifetime.

Bogoslaw (2007) felt that middle aged investors should concentrate on diversification and balance as strategies for asset allocation. If the investor has held an investment for a period of time, it is likely that things have changed. Stocks that were a small part of a portfolio could have grown in terms of the percentage of the portfolio over time. Morningstar has an asset allocation software program that is used to analyze the portfolios of new customers. The analysis is to show customers where they might have thought they were diversifying their portfolios but really they were only selecting different fund names that financially are moving the same way. It is also suggested that the middle aged investor really know their portfolio. If an investor began investing twenty years ago and only glances at the monthly or quarterly account statements, he or she may not have a true picture of what the portfolio is, how it has changed and what allocation adjustments may be needed. Bogoslaw also reminds the middle aged and older investor that he or she is less likely to be able to withstand a major crisis or downturn as compared to earlier in a career. The closer you are to retirement the more you want to concentrate on maximizing the return on the portfolio and to have a portfolio with high equity.

Bogoslaw discussed life-cycle funds which are investments that automatically change based on the age and life-cycle of the investor. Allocation changes are made automatically for the investor based on how close to retirement the investor may be. Life-cycle funds are desirable because they take "emotion" out of investing by using a life-cycle specific formula for selecting investment allocation.

Viewpoint

Small Investor Knowledge & Control

The small investor can be impacted by investment decisions that they don't make. Many small investors simply choose to invest in large companies or the programs offered by their employers because they aren't sure what to do. The small investor doesn't really know how a company is run or the people who make the decisions. Because of human nature, people may try to gain an advantage in investing. This has shown up in the investment world through high level company executives exaggerating company performance or selling shares of stock when they know that company performance will be poor. Financial managers have been known to give insider information to their favorite clients.

Serafin (2007) noted that even after mutual fund scandals and efforts by regulators to force independence in financial management decision-making, financial managers are still engaging in activity that hurts the small investor, especially passing on exclusive information. Serafin identified failed attempts by the Security and Exchange Commission (SEC) to require that fund boards be made up of outsiders. These were struck down in 2005 and 2006 although some complied voluntarily. The SEC wanted 75% of fund management boards to be made up of outsiders. Serafin indicated that 80% of mutual fund boards have made an effort to adhere to the 75% outsider guideline. However, the presence of outsiders hasn't seemed to improve performance and only reduce the likelihood of conflicts of interest. Serafin suggested the small investor pay attention to the costs associated with managing funds and how high the turnover is of fund managers.

On the other hand, many people would not get involved in investing if there wasn't a company investment program to participate in at work or professional fund managers to take the burden out of making financial decisions. Most average investors don't have the knowledge and don't feel confident in acquiring that knowledge in the time they have outside of work, family obligations and personal interests. In addition, if the investment does poorly, the professional manager or someone else can take the blame. It takes time and energy to set up and manage company investment programs; however, this is good business and provides for the security of workers. Most programs allow workers to invest a generous amount of income and some companies match the investment put in by the employee. The programs are an attractive and low involvement way that people can learn about and participate in investing.

Storch (2007, p. 9.) reported on lawsuits against large companies (Boeing, Kraft and others) charging that the companies allowed their employees to be charged extra fees in 401K plans. The fees are important because they offset the return investors get. Over the long term, slight reductions in the percentage of return can add up and significantly reduce the portfolio value for the employee investor. Someone else investing in the same thing and having the same portfolio would make much more money if the fees incurred to manage the portfolio are smaller. The companies were sued because it was felt they had a responsibility to manage the cost of 401K programs and to reduce the possible cost employees would incur. The Department of Labor has responded by requiring additional disclosure from companies with 401K plans. With activity like this, what is the small investor supposed to do? There are expected expenses with managing a 401K plan. Some of these include variable annuity expenses if insurance makes up part of the investment portfolio. There are also the costs of trades if the portfolio contains stocks or bonds. Surrender charges are incurred if the company decides to switch retirement plans. Similarly, there are market value charges if the investor decides to leave a guaranteed income plan. Mutual funds have a special 12(b)1 fee that goes to the financial advisor. Banks and other entities can be paid fees for managing the shareholder accounts and records. While these fees may be viewed as a convenience fee, they still negatively impact the return on investment.

No investment is foolproof and all eggs shouldn't go in the same basket. So employees of companies that have 401K plans shouldn't be the only place employees place their investments even if the company is large, established and has a long track record of success and loyalty to employees.

Terms & Concepts

Asset Allocation: How the assets in an investor's portfolio are allocated to different investments based on how much risk the investor can tolerate.

Diversification: An investment strategy where the investor divides up investment funds into different investments to achieve investment objectives and balance risk and return. This strategy ensures that the investor is not dependent on the performance of a single investment and doesn't endanger other assets based on poor performance.

Investment Objective: What the investor hopes to gain by investing.

Portfolio: A collection of investments or assets.

Portfolio Management: The process of managing money.

Risk: Is the uncertainty an investor faces regarding the return on an investment. Many factors affect risk.

Risk averse: An investor with a low tolerance for risk and who — with investment decisions — will choose to avoid risk more often than not. The risk averse investor can tolerate a lower return than high losses.

Bibliography

Blankson, S. (2005). Asset allocation: the key to financial security. Upper Saddle River, NJ: Prentice-Hall, Inc.

Benzoni, L., Collin-Dufresne, P. & Goldstein, R. S. (2007). Portfolio choice over the life-cycle when the stock and labor markets are cointegrated. Journal of Finance, 62, 2123-2167. Retrieved September 16, 2007 from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26438960&site=ehost-live

Bogoslaw, D. (2007, September 5). Do you have an age-appropriate portfolio? Business Week Online, 24. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26484629&site=ehost-live

Cane, B. (2007). Caring ever after. Bank Investment Consultant, 15, 31-35. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26448699&site=ehost-live

Joshi, R. (2007). Where to invest now? Business Today, 16, 149-152. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26375310&site=ehost-live

Mannes, G. (2007, February 13). Get your portfolio in balance. Money Magazine. Retrieved September 16, 2007 from http://money.cnn.com/2007/02/13/magazines/moneymag/asset%5fallocation.moneymag/index.htm

Morgenson, G. & Harvey, C. R. (2002). The New York Times dictionary of money investing. New York, NY: Times Books.

Serafin, T. (2007). Who's in charge here? Forbes, 180, 162-164. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26520028&site=ehost-live

SMITH, A. (2013). Smart Investors Keep It Simple. (cover story). Kiplinger's Personal Finance, 67, 36-37. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90617035&site=ehost-live

Sosnoff, M. (2013). Fear and leverage on wall and broad. Forbes, 192, 1. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91812091&site=ehost-live

Storch, K. (2007). True costs of 401(k) plans. Employee Benefit Plan Review, 62, 9-10. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26375016&site=bsi-live

Teller, J., & Kock, A. (2013). An empirical investigation on how portfolio risk management influences project portfolio success. International Journal of Project Management, 31, 817-829. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89114195&site=ehost-live

Suggested Reading

Clark, K. (2007). No amateur investing, please. U.S. News & World Report, 143, 70. Retrieved September 27, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26619670&site=bsi-live

Stock, H. J. (2007). Living the life. Bank Investment Consultant, 15, 23-25. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26448697&site=ehost-live

Stock, H. J. (2007). The baby boomer explosion could blow up in advisors' faces. Bank Investment Consultant, 15, 11. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26448695&site=ehost-live

Wang, P. (2007). Why bad returns don't make a bad fund. Money, 36, 70-72. Retrieved September 27, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26590522&site=bsi-live