Portfolio Investment

Portfolio investments are investments made in a group of assets (equity, debt, mutual funds, derivatives, or even bitcoins) instead of a single asset to earn returns commensurate with the investor's risk profile. Portfolio investments might vary from a small segment of one industry to a wide-ranging – entire market.

Like every investment in finance, the decision to invest in a portfolio or not is a choice. But the decision many people make here shows the obvious importance of portfolios in modern investing. They provide a method of customization exactly where it is necessary.

• Portfolio investments involve investing in diverse assets, such as equity, debt, mutual funds, derivatives, or even bitcoins, to achieve returns aligned with the investor's risk profile. It may range from a small segment of a single industry to a broad spectrum of the entire market.
• The types of portfolio investments are risk-free, low-risk, medium-risk, and high-risk portfolios.
• Investing in a portfolio is a choice, just like any other financial investment. However, many people's choices demonstrate the precise significance of portfolios in contemporary investment. Moreover, they offer a way to customize things exactly where needed.

Portfolio investment management is the process of allocation the funds into a wide range of financial instruments which may include mutual funds, stocks, bonds, exchange traded funds(ETFs) or any other types of securities with the aim of earning areturn according to the risk profile and return expectations.

In this process, a portfolio is constructed for an investor, which will include different types of assets where money can be put. This selection of financial instruments requires a good level of understanding of each of them and a careful analysis of the investor’s profile, financial goal and responsibilities.

But such type of investment methods provide corporations as well as individuals a good exposure to the various financial instruments available in the market. If the risk appetite of the investor is high, they can go for the ones that offer hih return with high risk. However, investors with low preference for risk would always prefer to go for safer investments.

Thus, best portfolio investment not only allow financial participation, but also risk management through diversification of holdings, with the ability to generate considerable and satisfactory returns over a period of time.

An investment gives returns in proportion to its risk factor. If one invests in highly risky assets like bitcoin, they can either get absurdly high returns or go to zero. But if one invests in treasury bonds, the risk factor is almost zero, but the returns are also very low. And each financial investor will have their risk profile tailored to their specific investments.

But the investments available in the market are not tailored to such needs. Hence each investor will have a specific requirement that can be maintained using a portfolio. The different types of diverse portfolio investment are as follows:

• Risk-Free Portfolios – Risk-free portfolios are the ones that have investment securities regarding treasury bonds and such where the risk is almost nil but low returns.
• Low-Risk Portfolios – A portfolio with majorly risk-free assets combined with risk-based securities gives a blend of low-risk, decent returns.
• Medium Risk Portfolios – A portfolio with more risk-free securities than the high-risk portfolio but fewer risk-based assets.
• High-Risk Portfolios – This portfolio investment includes many high-risk securities that benefit with high returns.

The thought that one can attain high returns with low risk is a difficult one to perceive. The free market dynamics call it arbitrage – when two similar risk profiles pay off at different scales, one of them has a benefit over the others. Such a difference slows the investors to pounce on the opportunity and neutralizes the benefit of the difference in returns for similar risk portfolios. This is called the law of one price, and such a law of one price does not allow the same risk assets to have the same price. One should keep this in mind while preparing a portfolio – any returns more than that for the specific risk rate will not stand the test of time.

Let us look at some important strategies that we should keep in mind while deciding investment in a portfolio of assets.

• Risk and return – Putting money in a portoilio of assets require a balance of return and risk. Investors should understand that a higher return will carry a higher risk and low risk does not have the potential to generate high return. Such options include bonds, certificate of deposits, treasury bills, etc. which have a guaranteed return that will be low along with low risk.
• Diversification – This strategy emphasises on selecting different asset classes across sectors and regions in order to spread the risk. This is very important because in this portfolio investment management, the loss of one will get compensated by the other, bring a balance to the entire investment and reducing the impact of any one asset’s performance on the overall portfolio.
• Allocation – As per the risk and return profile of the investor, it is necessary to allocate the fund in a systematic manner by determining a percentage for each financial instrument like stock, bond, etc, This is done after carefull analysis of market condition, investor’s risk and return profile and their financial goal.
• Focus on long-term- Investment in a diversified portfolio will involve a focus on a long term strategy which will spread overa number of years. It also involves regular and systematic monitoring, rebalancing and required adjustment in case the investor’s requirement and market conditions change.
• Alignment with objective – The portfolio should be aligned with the objective of designing it so that it serves the purpose of meeting the investor needs in the best way possible and with the time limit required.
• Professional management – The portfolio should be managed by professional who have proper knowledge and skill to understand and analyse it so that appropriate selection of investments take place and monitored form time to time in order to meet thej requirements.

Let us take an example scenario to see how best portfolio investment returns and risks are calculated and represented.

For this, we will imagine a treasury bond that yields a return of 2% per annum. Treasury bonds are considered risk-free because the US government backs them. So, the return's net variability/risk/variance will be zero. This means that the returns will be only 2% per annum a hundred percent of the time.

Let us assume a stock with an average return of 10% and a variance of 2%. This means that if the returns are normally distributed, the net returns lie between 8% and 12% for 68% of the time.

Precisely the reason why portfolios exist. If an investor builds a portfolio by investing 50% of his money in bonds and the rest in stock, he can have an average return of about 6%. This is higher than the mean returns of bonds and lower than the mean returns of a stock. If the investor wants to increase his risk, he can increase the share of stocks, and if he wants to decrease his risk, he can increase the share of his bonds.

The following are the advantages of portfolio investments.

• An individual’s risk profile can be met using diverse portfolio investment. It cannot be done by searching for a financial investment that allows the individual his risk profile.
• An individual can decide how to diversify his investments -by stocks, markets, or types of investments.
• Suppose the investor wants to manage different points of liquidity. It cannot be managed by one stock or one bond. But having a portfolio of assets will help him have a steady flow of income or flow of income at a necessary time.
• Not all stocks pay dividends. Some stocks pay dividends, and some stocks are growth stocks. If the investor's requirements from an investment stand somewhere in between, they can choose to invest in a portfolio that helps them benefit from dividends and growth stocks.
• Investing in such multiple assets requires minimal management. This will reduce the transactional cost of investment and help save additional costs.
• For people investing in multiple securities, the individual security analysis is not as important as the conjoint analysis. This helps in reducing the social cost of the investment.

The following are the disadvantages of diverse portfolio investment.

• One of the important reasons for proper stock market functioning is the information flow. Information flow is the theory where, because of the money involved, the decision-making during the stock price movement helps the company gauge the market's conditions and the general public. If the stock price moves after a certain decision, it helps the company decide whether it is a good decision. However, with balanced portfolio investment, the movement of such stock prices becomes more uncertain as the risk is gauged as a whole, and hence the flow of information is uncertain.
• If proper research is not done and a proper risk profile is not calculated, the portfolio will not yield optimum returns.
• To calculate the returns for a certain amount of risk, the person has to analyze multiple stocks and form a portfolio. Though companies available analyze these sorts of portfolios and provide them, that still does not benefit the user to a full extent.
• Financial knowledge is mandatory for people trying to invest by using a portfolio instead of individual stocks. The relations between individual stocks, stocks, and markets are difficult to analyze.

Both the above terms refer to two different approaches to investing. However there are some points of difference between them as follows:

• The former refers to putting money in a varied range of financial instruments with the aim of diversifying risk and earning a suitable return, whereas the latter refers to making a large investment in corporations or ventures with the aim of controlling and influencing the business operations.
• The control level for the former is very limited whereas the latter involved high level of control with active participation on management as well as company policies and directions.
• The risk level in case of the former is very less due to diversification according to the investor’s profile and financial aim The latter involves higher risk which totally depends on the performance of the company that in turn depends on internal operations and external factors like market conditions, economic stability, to name a few.
• The balanced portfolio investment is generally more liquid than direct investment. The latter, once done, is very difficult to change into cash. It involves various steps and is a time consuming process.

Thus, both types of investments have their own pros and cons. A proper understanding is necessary to take informed decisions.

This has been a guide to what is Portfolio Investment. We explain it with example, strategies, types, differences with direct investment & advantages. You can learn about Portfolios from the following articles –

• Combined Ratio
• Who is a Portfolio Manager?
• Portfolio Diversification Meaning
• Portfolio Rebalancing Definition