Portfolio Management Tips

Last week, I discussed the financial planning components of wealth management. Today, I’d like to focus on the portfolio management component, which involves a comprehensive overview of how investment portfolios should be designed, implemented, and actively managed on a regular basis.

The first step is to design a portfolio that is customized to a particular target rate-of-return with the minimum level of risk. Next, calculate the expected return and expected risk of each asset class such as stocks, bonds, cash, and alternative investments. Then, using this data, calculate the portfolio with the lowest risk level at each different rate-of-return. This ensures the most efficient portfolio, which is the one with the desired rate-of-return with the lowest risk level.

The next step is to design a customized asset allocation model that will earn the targeted rate-of-return while reducing unnecessary risk and controlling investment expenses and taxes. This model is then documented in a written Investment Policy Statement that specifies financial goals, targeted rate-of-return, targeted asset allocation, risk tolerance level, expected deposits and withdrawals, and investment time horizon. This document establishes a blueprint for the portfolio, sets goals, and ensures clear communication.

With the strategy mapped out, the next step is to implement the plan by deciding how to diversify within each asset class in the selection of specific investment products. In this selection process, many factors are considered, including economic conditions, possible inflationary or deflationary effects, tax consequences, total expected return, diversification, and risk vs. return.

Given the dynamic nature of the markets, portfolios need to be rebalanced periodically so that the actual asset allocation is matched more closely to the target asset allocation. Portfolios should be rebalanced whenever necessary, such as following major market moves. This is an automatic “buy low, sell high” strategy. Buy into an asset class when prices are lower and sell some of the asset classes when prices are higher.

A portfolio’s risk and overall performance should be measured in regular reports showing how well (or not so well) it is actually achieving its goals. These reports should measure and compare actual asset allocation to target allocation, actual rate-of-return to the goal rate-of-return and the actual risk level to the index’s risk level.

In addition, annual reviews should be held to monitor return, risk, and allocation. Target asset allocation may need to be recalculated to accommodate any changes in a given financial situation. For example, if there is a need for a one-time cash withdrawal, the portfolio should be adjusted accordingly. Finally, it is important that the Investment Policy Statement be updated so that the portfolio remains on track and continues to best meet its goals year after year.