Personal finance: Portfolio management and everything it entails

You must have heard the proverb, "Don't put all your eggs in one basket". While the proverb applies to many aspects of life, it is equally relevant in investment decisions.

If you put all your money in a single asset class or a financial product, and that asset class/financial product falls sharply, you will incur huge losses, and you will have to compromise on your financial goals. Therefore, you should always have an investment portfolio and manage it until you achieve your financial goals.

You will learn what portfolio management is and some related concepts in this article.

Also read: Best investment options in India

What is portfolio management?
 

The objective of portfolio management is to allocate money to a variety of asset classes and manage them to reach an investor's long-term financial goals. The asset classes and the money allocated to each are designed to match the investor's risk profile, and the portfolio earns optimal risk-adjusted returns.

 Portfolio management is composed of two words:

1) Portfolio: It involves identifying various asset classes to build a diversified investment portfolio that matches the investor's risk profile.
 

2) Management: A portfolio of investments must be reviewed regularly and rebalanced when necessary until the investor's financial goals are met.

Now that you understand what is portfolio management, here are some related concepts:

Asset allocation

Asset allocation is the process of investing money in various asset classes. Each one of them has a specific role to play in your investment portfolio as follows:

a) Domestic equity: It can give inflation-beating high returns and generate wealth for you in the long run. It carries a high risk and is suitable for investors with an aggressive risk profile. Equities are an excellent financial product for investing towards long term financial goals such as building a fund for a child's higher education or own retirement.
 

b) International equity: It hedges country-specific risk. It also provides the benefit of Indian (INR) currency depreciation against the US Dollar, which enhances your overall returns. Like domestic equities, it has the potential to generate high returns. Due to the high risk involved, it is suitable for investors with an aggressive risk profile.

c) Fixed income: It stabilises the overall investment portfolio when equities are volatile or falling. It provides regular interest income. It carries relatively lower risk than equities and is suitable for investors with a low to moderate risk profile.
 

d) Gold: It is considered a hedge against inflation. It is also considered a haven during times of uncertainty, such as a pandemic, war, political instability, etc.
 

Different asset classes outperform each other. You cannot predict which asset class will give the best returns next year and in the years ahead. Hence, your investment portfolio should have a diversified asset allocation.

Risk management and diversification

In the earlier section, you understood why you should follow asset allocation. When building a diversified investment portfolio, you should consider your risk profile to decide the percentage allocation to each asset class.

a) Aggressive risk profile: If you have an aggressive risk profile, you may allocate a higher percentage of your overall investment portfolio to equities and a lower percentage to fixed income. You should invest in equity mutual funds rather than buying shares directly from the stock market. Within equities, you may further divide the allocation among domestic and international equities. Equity mutual funds can also be selected based on active and passive mutual funds.
 

b) Moderate risk profile: If you have a moderate risk profile, you may split the allocation between equities and fixed income equally, with some allocation to gold. If you don't wish to invest separately in equities and fixed income, consider investing in hybrid mutual funds. They provide you with a combination of equity and fixed income in a single mutual fund scheme.
 

c) Conservative risk profile: If your risk appetite is low, you may allocate a higher percentage of your investment portfolio to fixed income and a lower percentage to equities. You may consider investing in conservative hybrid funds that combine fixed income (75 to 90%) and equities (10 to 25%).
 

Apart from risk appetite, an individual's risk profile may be influenced by other factors, such as,
 

a) Age: As age increases, risk appetite diminishes.

b) Financial liabilities: A higher-value loan, such as a home loan, may reduce your risk appetite for investments that are high-risk.
 

c) Financial responsibilities: When you get married and have children, the additional financial responsibilities may reduce the risk appetite for high-risk investments.
 

d) Time left to achieve financial goals: As the time to achieve the financial goal comes closer, you may prefer to shift the investment from riskier investment options to safer ones.
 

Portfolio performance evaluation

Based on the above discussion, you have formulated an investment portfolio with appropriate asset allocation and diversification that suits your risk profile. Now you need to evaluate the investment portfolio's performance.

a) You should review the investment portfolio performance once every six months to 1 year.

b) Compare the returns of each asset class and the overall investment portfolio returns with the expected returns. If any financial products are not performing as expected, evaluate the reasons for the underperformance.

c) Take corrective action, such as replacing the underperforming financial product with an appropriate replacement.

d) If some new asset class or financial product has been introduced, consider including it in your investment portfolio if it fits the inclusion criteria.

Rebalancing

While evaluating investment portfolio performance, you may notice that the weightage of a particular asset class has increased due to its outperformance compared to other asset classes. In such cases, you need to rebalance your portfolio.

For example, you have an asset allocation of equity and debt in a 75:25 ratio. Of every Rs. 100 invested, Rs. 75 goes to equity and the remaining Rs. 25 to debt.

Let us assume that the equity investment has appreciated by 20% and the debt investment has appreciated by 5% in the last year. In this case, the equity investment is worth Rs. 90 and the debt investment is worth Rs. 26.25, making the overall investment portfolio worth Rs. 116.25. The equity and debt asset allocation ratio has changed to 77:23.

To rebalance, you must sell some equity and invest the proceeds in debt, so that the equity and debt asset allocations return to 75:25.

You can invest in hybrid or multi-asset allocation mutual funds to avoid the challenges of portfolio rebalancing.

Investing in a hybrid fund exposes you to both equity and debt, while investing in a multi-asset class fund exposes you to at least three asset classes with a minimum allocation of 10% to each.

An expert fund manager rebalances portfolios regularly on behalf of investors in hybrid and multi-asset allocation schemes. 

Also read: Invest in Fixed Deposits for these five reasons

Active vs passive portfolio management 

There are two portfolio management styles- active and passive.

1) Active portfolio management
 

It involves actively buying and selling securities (equity, debt, gold, etc.) to beat benchmark indices or the broader markets. A hands-on approach is used to maximize returns. Undervalued securities are identified using quantitative or qualitative methods and then sold at a profit.

2) Passive portfolio management
 

It involves buying a fixed set of securities (equity, debt, etc.) and holding them long-term. The objective is to earn benchmark returns. It is done using index funds and exchange traded funds (ETFs) on various equity and debt indices.

IDFC FIRST Bank allows you to invest in various mutual funds. You can choose from equity, debt, hybrid, multi-asset class funds, etc.

You can invest in active mutual funds if you prefer active portfolio management. IDFC FIRST Bank offers various index funds if you prefer passive portfolio management. The bank provides personalised investment solutions for your financial goals.

To sum up

Portfolio management is the key to achieving your financial goals.

Portfolio management involves building an investment portfolio based on asset allocation and diversification that suits your risk profile. Regularly reviewing and rebalancing the investment portfolio is essential once the portfolio has been built. Until you reach your financial goals, the process continues.

Disclaimer

The contents of this article/infographic/picture/video are meant solely for information purposes. The contents are generic in nature and for informational purposes only. It is not a substitute for specific advice in your own circumstances. The information is subject to updation, completion, revision, verification and amendment and the same may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject IDFC FIRST Bank or its affiliates to any licensing or registration requirements. IDFC FIRST Bank shall not be responsible for any direct/indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information mentioned. Please consult your financial advisor before making any financial decision.