Investment management is the process of creating a portfolio of securities (stocks, bonds and other securities/assets) to achieve a specific goal. There are numerous considerations to consider before you form your portfolio. For example, you must define your investment objective, claim your accepted level of risk, determine your investment style and finally, outline your level of diversification.
Portfolio objective
Defining your portfolio objective is the first step in the investment management process. You need to determine your investment goals, horizon and accepted level of risk. Is the goal of your portfolio to preserve capital, provide income or provide long-term capital gains? To determine your investment horizon, you need to ask yourself when you want to access the money. If you are investing to buy a car in five years, then you have a five-year horizon. If you are investing for retirement, you might have a 20- or 30-year horizon. Your investment horizon will play an important role in determining what securities you should buy.
Level of accepted risk
Your goal is to achieve the best return for your portfolio with the least amount of risk. Unfortunately, higher return usually means higher risk. How do you determine what level of risk you should take? There is a standard guideline that investors can follow. A conservative investor doesn’t invest in securities that he or she thinks will lose their value if there is downturn in the market. A moderate investor may be able to swallow a little fluctuation in returns and portfolio value, but will not want to risk too much money. An aggressive investor can tolerate losing their initial investment in exchange for the possibility of greater returns.
Investment style (growth, value, balanced)
Once you know your accepted level of risk, you can define your portfolio’s overall style. A conservative investor might just invest in cash or bonds. A moderate risk investor might choose a balanced portfolio of both stocks and bonds. An aggressive, high risk investor might choose stocks from start-up companies or companies based in emerging markets. Within each asset class, there are degrees of risk. For example in the cash and bond asset class you can invest in low-risk treasury bills, CDs, or money market funds. Bonds rated AAA are lower risk than high yield junk bonds because junk bond issuers might be more likely to default on their loan. In the stocks category you can choose between value companies or growth companies, small and large cap, or developed and emerging.
Level of diversification
Your level of diversification will also impact your returns and risk. Diversification can be defined as not putting all your eggs in one basket. If you invested 100% of your money in India, and India experiences a major natural disaster, there’s a good chance you could lose your entire investment. As a result, sophisticated investors diversify their risk by creating a diversified portfolio of stocks, bonds, cash, real estate, and other instruments. In addition, they diversify by country, region, industry and size of company. Diversifying lowers the overall risk of the portfolio because not all asset classes behave the same way under similar market conditions.
Conclusion
Not all investors are alike. Some prefer less risk, some prefer more. Those who want more risk can find opportunities in the equity markets, whereas those who want less can increase their investment in cash and bonds, and diversifying with other asset classes (ex. real estate). Customizing the portfolio to your risk and return objective is the key to successful investment management.
– Research optimus
