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A portfolio refers to a collection of investment tools such as stocks, shares, mutual funds, bonds, cash and so on depending on the investors income, budget and convenient time frame. Following are the two types of Portfolio: 1. arket Portfolio !. "ero #nvestment Portfolio
1. Portfolio is a group of financial assets such as shares, stocks, bonds, debt instruments, mutual funds, cash e'uivalents, etc. A portfolio is planned to stabili(e the risk of non*performance of various pools of investment. !. Management is the organi(ation and coordination of the activities of an enterprise in accordance with well*defined policies and in achievement of its pre* defined ob&ectives. +ow let)s comprehend the meaning of term Portfolio anagement
Portfolio Management ,P - guides the investor in a method of selecting the best available securities that will provide the e%pected rate of return for any given degree of risk and also to mitigate ,reduce- the risks. #t is a strategic decision which is addressed by the top*level managers. For e%ample, .onsider r. /ohn has 0111,111 and wants to invest his money in the financial market other than real estate investments. 2ere, the rational ob&ective of the investor , r. /ohn- is to earn a considerable rate of return with less possible risk. 3o, the ideal recommended portfolio for investor r. /ohn can be as follows:*
!ecurity of Principal "nvestment : #nvestment safety or minimi(ation of risks is one of the most important ob&ectives of portfolio management. Portfolio management not only involves keeping the investment intact but also contributes towards the growth of its purchasing power over the period. $he motive of a financial portfolio management is to ensure that the investment is absolutely safe. 4ther factors such as income, growth, etc., are considered only after the safety of investment is ensured. #onsistency of $eturns : Portfolio management also ensures to provide the stability of returns by reinvesting the same earned returns in profitable and good portfolios. $he portfolio helps to yield steady returns. $he earned returns should compensate the opportunity cost of the funds invested.
#apital %ro&th : Portfolio management guarantees the growth of capital by reinvesting in growth securities or by the purchase of the growth securities. A portfolio shall appreciate in value, in order to safeguard the investor from any erosion in purchasing power due to inflation and other economic factors. A portfolio must consist of those investments, which tend to appreciate in real value after ad&usting for inflation.
Marketability : Portfolio management ensures the fle%ibility to the investment portfolio. A portfolio consists of such investment, which can be marketed and traded. 3uppose, if your portfolio contains too many unlisted or inactive shares, then there would be problems to do trading like switching from one investment to another. #t is always recommended to invest only in those shares and securities which are listed on ma&or stock e%changes, and also, which are actively traded.
'i(uidity : Portfolio management is planned in such a way that it facilitates to take ma%imum advantage of various good opportunities upcoming in the market. $he portfolio should always ensure that there are enough funds available at short notice to take care of the investors li'uidity re'uirements.
Diversification of Portfolio : Portfolio management is purposely designed to reduce the risk of loss of capital and5or income by investing in different types of securities available in a wide range of industries. $he investors shall be aware of the fact that there is no such thing as a (ero risk investment. ore over relatively low risk investment give correspondingly a lower return to their financial portfolio.
)avorable Tax !tatus : Portfolio management is planned in such a way to increase the effective yield an investor gets from his surplus invested funds. 6y minimi(ing the ta% burden, yield can be effectively improved. A good portfolio should give a favorable ta% shelter to the investors. $he portfolio should be evaluated after considering income ta%, capital gains ta%, and other ta%es.
$he ob&ectives of portfolio management are applicable to all financial portfolios. $hese ob&ectives, if considered, results in a proper analytical approach towards the growth of the portfolio. Furthermore, overall risk needs to be maintained at the acceptable level by developing a balanced and efficient portfolio. Finally, a good portfolio of growth stocks often satisfies all ob&ectives of portfolio management.
Meaning Of Diversification
7iversification is a techni'ue that reduces risk by allocating investments among various financial instruments, industries and other categories. #t aims to ma%imi(e return by investing in different areas that would each react differently to the same event. ost investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long*range financial goals while minimi(ing risk. 2ere, we look at why this is true, and how to accomplish diversification in your portfolio
*ndiversifiable * Also known as 8systematic8 or 8market risk,8 undiversifiable risk is associated with every company. .auses are things like inflation rates, e%change rates, political instability, war and interest rates. $his type of risk is not specific to a particular company or industry, and it cannot be eliminated, or reduced, through diversification9 it is &ust a risk that investors must accept. Diversifiable * $his risk is also known as 8unsystematic risk,8 and it is specific to a company, industry, market, economy or country9 it can be reduced through diversification. $he most common sources of unsystematic risk are business risk and financial risk. $hus, the aim is to invest in various assets so that they will not all be affected the same way by market events.
returns. 3ources of systematic risk would be macroeconomic factors such as interest rates, inflation, recession, wars, etc. that affect the entire market. <nsystematic risk is company specific or industry risk. $his risk can be nearly diversified away.
Examples of Diversification
,sset ,llocation !trategies to Mitigate !ystematic $isk 3ystematic, or market risk, can be partially mitigated in an investment portfolio through asset allocation. Asset allocation involves dividing specific percentages of an investment portfolio among different markets and classes. Asset categories such as e'uities, bonds, cash, and alternative investments may not move in the same direction at the same time. O&ning a -ariety of "ndustries and !tocks to Mitigate *nsystematic $isk <nsystematic risk is the risk specific to a particular company or industry. ;ou never know when something negative might happen even to the best companies or industries. 7iversification can lower the risk ,volatility- of an investment portfolio because not all industries or stocks move together. <nsystematic risk can nearly be eliminated by holding a variety of non*correlated assets. #n other words, if an investor owns many non* correlated investments, the harm done by one company or industry having an unwelcome e%perience will be minimi(ed.
Diversification Advantages
$he advantages of diversification are risk management and portfolio optimi(ation. =isk management is one of the keys to successful investing. #f you lose >1? of your portfolio, it takes a 111? gain to get back to breakeven. #f you lose 11? of your portfolio, it only takes an 11? gain to get back to breakeven. 7iversification through asset allocation may be the most important investment strategy an investor can master. Portfolio optimi(ation is achieved by placing a larger percentage of high return investments in a diversified portfolio. 6ecause proper diversification lowers the overall risk of a portfolio, a portfolio manager can place more aggressive assets in the portfolio. #n other words, a portfolio manager, willing to take a given amount of risk, can invest more aggressively with a properly diversified portfolio as opposed to a non*diversified portfolio. Investment portfolio diversification is the strategy of combining assets in such a way as to reduce the overall risk of a portfolio. @%amples of how to achieve investment diversification are asset allocation and owning a variety of industries and stocks. $he advantages of diversification are lowered overall portfolio risk without lowering portfolio returns.
finally .ash. #ts important to do this kind of diversification if you are not an e%pert in one asset class and can not handle it fully. 23 Within ,sset #lass Ghen you invest your money in one asset class but in different kind of instrument or company , you are diversifying it across various instruments of same types. A very simple e%ample is opening Fi%ed 7eposits in various banks. #f you had to open a 11 lacs F7 , the chances are you will choose E banks and put !.> lacs in each rather than doing it for 11 lacs in &ust one bank. #n the same way some one investing in > different e'uity mutual funds. Ghile the underlying asset class is e%actly same ,e'uities- , but still some kind of diversification is there ,different fund managers handling it-. 43 %eography Wise $hen you can diversify location wise or geography wise. ;ou can invest in real estate in #ndia, <3 , <I .. ;ou can also invest in real estate across different cities within #ndia . ;ou can buy stocks in #ndian stock market, <3 stock markets and other countries too. $he idea is to take advantage of currencies fluctuations too, but this is only for e%perts who understand that. 53 ,cross #apitali6ation Ghen you invest in mutual funds, you can choose to invest in small cap funds, large cap funds, e%tra large cap funds, small companies , big companies, etc etc. +ote that the risk and return potential will be different and anyways you will invest in different
.3 ,cross !tyle $here can be diversification across styles D ;ou can invest in products giving you
fi%ed income, or which are &ust for growth purpose. ;ou can invest in some thing which has value investing principles or more of speculative ideas . .an you think about more kind of diversification or any other benefits for portfolio diversification C
Below are the two known diversification methods for your knowledge:
=isk and return are balanced out through diversification. $he value of stocks and bonds often e%hibit an inverse relationship. 3maller*company ,or small*cap- stocks and larger* company ,large*cap- stocks behave differently from each other. 3imilarly, stocks chosen using a value approach differ in performance from growth stocks. 6y combining small*, midsi(e*, and large*company stocks with growth and value styles of investing, as well as foreign stocks, you can produce a portfolio with different risks for the level of return you desire. Alternatively, you can seek a higher e%pected return if you can tolerate a higher level of risk. Another reason that diversification is important is because it is impossible to predict the market. For e%ample, this chart illustrates the various foreign sectors and their return on investment for the years !11!* !11K. As you can see, there is no discernible pattern from year to year:
, diversified portfolio generally has its investments divided over four asset classes9
!tocks represent the most aggressive portion of your portfolio. 3tocks provide the opportunity for higher growth over the long*term. 6ut this greater potential reward carries a greater risk, particularly in the short*term, because market volatility may mean your investment is worth less when you sell it. :onds generally provide regular income and less volatility than stocks, and can act as a cushion against the unpredictable ups and downs of the stock market. 4ften, bonds do not move in the same direction as stocks. #nvestors who are more concerned about safety rather than growth often allocate more of their portfolio
toward $reasury or other high*'uality bonds rather than stocks. $hat safety has a price, though: any bonds, especially high*'uality bonds, wont offer returns as high as stocks over the long term. !hort;term investments include money market funds and short*term certificates of deposit. oney market funds are conservative investments that offer easy access to your money and stability of principal. $heir goal is to preserve the value of your investment at 01 per share, but in e%change for that safety, money market funds usually have lower returns than bond funds or individual bonds. Ghile money market funds are considered safe and conservative, however, they are not insured or guaranteed by the Federal 7eposit #nsurance .orporation ,F7#.- the way most .7s are. "nternational stocks and bonds often perform differently than their <.3. counterparts, and provide e%posure to parts of the world not represented by <.3. fi%ed income securities. #f youre thinking like a global investor and have a healthy appetite for risk, consider some allocation to foreign stocks. $he <.3. stock market, though huge, represents roughly &ust half the global stock market.
13$educing volatility
A mi% of these asset classes can help you construct a portfolio that has fewer e%treme swings than a non*diversified one. $he pie charts below represent portfolios with different allocations for different risk profiles. $he average annual return for each portfolio ,from 1L!J through !111, including reinvested dividends and other earnings- is noted for each portfolio, as is the highest and lowest one*year returns. $he most aggressive portfolio, made up of K1? <.3. stocks and F1? international stocks, had an average annual return of 11?. #ts highest one*year return veered from a high of &ust under 1JF? to a loss of nearly JM?. $hats a lot of volatility for some people to stomach. Adding a little fi%ed income to the portfolio, however, lessens the range of those swings without giving up too much over the long haul: 6y adding a >? allocation to short*term investments and !>? to bonds and lessening the stock allocation to EL? and international to !1?, the portfolio would have returned almost L? over the same period, with lower e%tremes on the high and low end. $he more fi%ed income you add, the lower your portfolios volatility generally is, but youll also probably give up a little return.
in stocks may be appropriate. #nvestors with a long time hori(on but are more risk*averse may opt for a more balanced portfolio. @ven the most aggressive asset allocation model, however, should consider a fi%ed income component to help reduce the overall volatility of the portfolio. As you get closer to your goalNor if your goal is five to 11 years in the future when you begin savingNyou may want to shift your investments into more conservative securities, like fi%ed income mutual funds ,instead of stock funds- or certain individual bonds such as short term $reasury securities. Adding more conservative fi%ed income investments to a portfolio can help to modulate the ups and downs found in e'uity investments, a key factor when youre e%pecting to need the money soon. #n retirement, a good portion of your portfolio should be in stable, income*producing investments, but &ust like few portfolios should be 111? in stocks, few should be 111? in bonds. @ven retirees will need a certain amount of growth*oriented investments to combat inflation and, especially for younger retirees, invest for growth over what could be a decades*long retirement. =egardless of the asset allocation model that you choose, a diversified portfolio can help you achieve success in meeting your future goals. A well thought*out plan is critical: ;our money is too important to invest without a plan. ,n investment in a money market fund is not insured or guaranteed by the )ederal Deposit "nsurance #orporation or any other government agency3 ,lthough the fund seeks to preserve the value of your investment at <13== per share> it is possible to lose money by investing in the fund3 #n general the bond market is volatile, and fi%ed income securities carry interest rate risk. ,As interest rates rise, bond prices usually fall, and vice versa. $his effect is usually more pronounced for longer*term securities.- Fi%ed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Any fi%ed*income security sold or redeemed prior to maturity may be sub&ect to a substantial gain or loss. 3tock markets, especially foreign markets, are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments. :efore investing> consider the funds? investment ob ectives> risks> charges> and expenses3 #ontact )idelity for a prospectus or> if available> a summary prospectus containing this information3 $ead it carefully3
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A&ay a software engineer earning =s F>,111 monthly ,post ta%- with a Family of F ,1 wife and 1 kid- has following portfolio @%penditure : !1,111 per month Portfolio 9 Tax savers Mutual funds 9 1 lacs ,locked for another ! years$eal 0state Aa land in his native place > pahari in *PB 9 F.K> lacs )ixed Deposits Afor 7 yearsB 9 ! lacs PP) 9 F lacs #ash Ain bankB 9 =s !>,111
"nsurance Payout 9 2e pay >>,111 per year as life insurance premium for an endowment policy , for which he is insured for 1!.> lacs for !1 years . he started this policy before E years. 8is )uture plans * 2is goals are to buy a home in another > years for which he need downpayment of F*E lacs * Gant to save 11 lacs for his son education in 11 years * 2e want to retire early with montly income of E>,111 atleast . This Portfolio looks like diversified, and yes it is, b t not in a !ell mannered !ay" The assest &ise allocation is E# ity $ %&' Debt $ ()"*' +eal Estate $ *&' ,ash $ -"*' 2is overall Portfolio 3hortcoming * 2is e%posure to different asset class is not well balanced according to his over all situation * 2is :ife insurance is very less and and not at all enough . For this he is paying a hefty amount every year which adds a lot to his burden. * 2is @'uity Allocation needs to go up * his 7ebt allocation needs to go down * 2is cash needs to go up for li'uidity. none of his investments in any asset class provide li'uidity or near term li'uidity , #f he needs 1 lacs suddenly he cant get it , or will get it after breaking his F7. !uggestions 9 * $he first thing he must do is to restructure his portfolio.
* 2e shall surrender his e%isting @ndowment policy and take a $erm #nsurance ,=ead my artirticle on term insurance if you dont know what it is - of F>*E1 lacs for !1 years for which he will pay around 1F111*1E111 per annum. he will save surplus of E1,111 per year because of this.Also when he surrenders the policy he will get back around =s. !.E lacs back. * 2e must invest more in 3hares and utual funds ,as his risk taking capabilities is more because of his less age and less dependents* $he land in his native place is not appreciating in value much faster unlike other places like other real*estate hot spots. 2e shall consider buying his home sooner and sell his land at native place. if he sells his land he will get around E lacs. * Gith the money he gets from surrendering policy ,!.E lacs- and selling his land ,E lacs- , he will get around J.E lacs and he should utili(e this money as the down payment for new flat and rest he can take as 2ome :oan. 2e can do it later if he wants ,when he can afford the monthy @ #* 2e shall consider increasing his .ash to a level which can meet his contingent needs if any arised. 2e shall have atleast ! to F times of his monthly e%penses as contingency fund , which is totally li'uid. * Also apart from .ash and investing in $a% saver mutual funds , he shall consider investing in some non*ta% saver mutual funds which also gives him near li'uidiity. * 2e may leave the debt investments as it is . #f he wants he can break his F7 incase he is going for the 2ome loan , he can increase the down payement part from this money. ; "ncase he is going to take home loan after 1 year > he can also take some loan on his PP) > atleast for some part he &ill pay less interest than the home loan3 * Also he shall invest some money in O4:7 , to give more stability and security to his portfolio. * Atlast he shall consider taking a Family floater 2ealth #nsurance plan , which helps him to secure his Family from and health problems or illness. +ecommended Portfolio Apart from 2is 2ome ,considering he takes 2ome soon@'uity J>? , 7irect shares !1? , @'uity Funds J1? , 6alanced Funds !1?7ebt !1? Oold ,@$F- 11?
.ash >? Diversification does not say that you have to invest in some money in every asset class for sure , the idea behind it is just that the risk is minimized by diversification and the portfolio is more stable. ;ou can download a file to manage and note down your investments and it can serve as your portfolio file. :ocation of file is : http:55manish.pucsd.googlepages.com5portfolio.%ls 2appy diversifying :# would be happy to read your comments or disagreement on any topic. Please leave a comment. ;our diversification and portfolio
$he basic diversification proposition is that overall risk can be reduced by combining risky investments that are imperfectly correlated with one another. 6y doing this investors can diversify away unsystematic risk from their portfolios. #f this sounds too comple% we can encapsulate it in more prosaic, straightforward advice: don.t p t all yo r eggs in one basket. Portfolio 8oldings A!ep 2C> 2=12B 0(uity .ummins #.#.# 6ank P$. #ndia +$P. /aiprakash Asso $orrent Power =eliance #nfra :arsen Ou& ineral /indal 3tainles $ata Power I@. #nt /indal 3teel .airn #ndia 6a&a& @lectric =eliance #7F. $herma% 3terlite #nd .rompton Oreave Iirloskar 6ros Iirloskar Pneum A:3$4 #ndia !ector @ngineering P .apital Ooods 6anking P Financial 3ervices 3ervices <tilities .ement P .onstruction <tilities <tilities @ngineering P .apital Ooods etals P ining etals P ining <tilities @ngineering P .apital Ooods etals P ining 4il P Oas .onsumer 7urables 4il P Oas 6anking P Financial 3ervices @ngineering P .apital Ooods etals P ining @ngineering P .apital Ooods @ngineering P .apital Ooods @ngineering P .apital Ooods @ngineering P .apital Ooods $elecommunication @ngineering P .apital Dty -alue A$s crB E
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#onclusions
Ghile there)s no substitute for choosing the better of two stocks, choosing direct competitors in the same industry is an effective way of spreading the risk. #n effect, it)s a mini*diversification, averaging out both risks and gains. Ghen performing this mini* diversification, the winning strategy over the long run will be to 8chase yields8, reinvesting the full amount from both companies into the one with the higher yield at the time. #n fact, this result can be e%tended to an entire portfolio, where reinvesting into your companies with the highest yield may give you a higher return than investing in each company with its own returns. #n following this strategy, there are several pitfalls to look out for:
Always maintain balance * whether reinvesting in the same industry or several, it is necessary to be mindful of diversification as your different positions grow at different rates Following this strategy across an entire portfolio is best done with companies e%hibiting similar levels of growth and risk. =einvesting from a low*yield*high* growth company into a high*yield*low*growth company is an entirely different situation from what)s presented here #f you)re convinced that company A is going to do better than company 6 over the long run, buy company AH $here)s no substitution for choosing the better company.
# hope # was able to present something meaningful to your investing strategy. =isk mitigation is a recurring theme in my decisions and this analysis shows me how to optimi(e my gains while maintaining this risk. Please leave comments below. #)d like to hear some more interpretations of the data, or find out what you would do in this situation.
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