What Is Portfolio Management and Should You Use It?

Portfolio management is a very broad term and it may be easy to overlook what exactly it means. In fact, it opens up a very wide range of nearly endless decisions. So what exactly is portfolio management? 

Investopedia describes it as, “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.”

In other words, investors have to first determine their objectives and then find suitable investments as a result. While there will be plenty of overlap among investors, the answers can vary quite a bit.

As a young employee at the start of their career, the objective would be to maximize long-term growth in their portfolio. They will already have to work 30 to 40 years and need their investments to do the heavy lifting with the added benefit of time. Investors with less than five years left before retirement have a different objective. While they still need growth to get them through retired life, they also need to strongly consider capital preservation. How many soon-to-be-retired investors had to stick it out another 5+ years at work because their portfolios were decimated during the Great Recession? Finally, for our last example, look at the short-term trader. Their objective is to preserve all of their capital and take advantage of high-quality risk/reward situations that quickly generate cash flow.

Again, there are a ton of different answers here, but they all boil down to one thing: investment objectives. When we know our objectives — long-term growth, dividend income, capital preservation, short-term cash flow trades, etc. — we can begin to build our portfolios around those objectives.

Then they can start to hone in on the other two aspects mentioned at the top: asset allocation and “balancing risk against performance.”  

These two topics could be discussions on their own (and they will be), but for now, let’s keep it concise. Asset allocation refers to what percentage of the portfolio will be allocated to specific assets. Generally speaking, it refers to three categories, that being cash, stocks and bonds (and more commonly, just the last two). However, there are many more asset classes to consider, such as gold, futures, options, commodities, real estate and partnerships, among other options.

When it comes to “balancing risk against performance,” it simply means investors need to consider the risk of their chosen assets vs. the performance they are seeking. One wouldn’t need to load up on tech stocks if they were looking to achieve consist income on low-volatility positions.

What Else in Portfolio Management?

The cited description for portfolio management also reads, “Portfolio management is all about determining strengths, weaknesses, opportunities and threats in the choice of debt vs. equity, domestic vs. international, growth vs. safety, and many other trade-offs encountered in the attempt to maximize return at a given appetite for risk.”

This perfectly ties into what we were just talking about with asset allocation and risk vs. performance. Essentially, investors need to determine which pieces of the investment world best fit their puzzle. At the end of the day, they are managing for their and their family’s future, no one else’s.

But it goes beyond simply choosing the types of assets an investor wants in their portfolio. They have to decide things like actively or passively managed funds, or whether to use an investment advisor to help make financial decisions.

Portfolio Management in Trading

Investors who use their portfolios to trade need strict parameters in order to survive the harsh world of trading. Be it equities, futures, bonds, forex or options, there are periods of boom and moments of bust. Knowing when to sit on one’s hands and when to pounce are very important. But without a rules-based approach, many investors will do just the opposite; pouncing at the wrong times and doubling down at a time where they should be sitting on the sidelines.

Even when times are good, following the rules are key. While we can “get away” with breaking these rules at times, it only reinforces bad habits. Using backtests and simulators can certainly help, as it never hurts to have the odds on your side.

When it comes to options, using Option Party’s Portfolio Manager solution can provide a big boost. By being able to completely customize our trading strategy, users can tweak every essential part of the trade. This ranges from entry, exit, risk, cash reserve and position sizing, (along with the strategy of course).

These types of tools may not seem like portfolio management, but they can go a long way in making sure investors have the proper exposure. Too much risk can doom a portfolio. Not enough risk when the opportunity is right can cost investors performance as well. Balancing it is key, whether the outlook is 30 minutes or 30 years. These strategies can also help with execution, confidence and perfecting the strategy at hand.