What Is Portfolio Management?

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Updated on Friday, July 17, 2020

Portfolio management is a specific investment approach that includes building and managing your investment portfolio through buying and selling securities and other investments to meet your short-term and long-term goals.

While you can do portfolio management on your own, you can also hire a professional portfolio manager. A professional portfolio manager will handle your investment account on your behalf, whether through active or passive management. We’ll cover what portfolio management entails to help you decide if a portfolio manager is right for you.

What does a portfolio manager do?

A licensed portfolio manager works on your investment portfolio on your behalf, selecting appropriate investments and overseeing your portfolio to help you achieve your financial goals.

A portfolio manager takes into account your objectives, risk tolerance, time horizon and any preferences you have regarding which securities you would like to invest in. They then measure risk and reward with expert analysis to find the right investments based on your goals and preferences.

Active vs. passive portfolio management

There are two types of portfolio management: active portfolio management and passive portfolio management. Your risk tolerance might determine your portfolio management style.

Active portfolio management: This involves a portfolio manager strategically buying and selling individual stocks and other securities in an effort to beat benchmark performance. The portfolio manager will review a stock’s history, potential earning power and other considerations when deciding whether to buy or sell.

Active portfolio management tends to have a higher risk since you’re looking to beat a benchmark, but this also means you could see potentially higher rewards (or, on the flip side, larger losses). Active portfolio management with a portfolio manager tends to have higher fees compared with passive portfolios because there is more buying and selling involved.

Passive portfolio management: Passive portfolio management is mostly hands-off. Instead of hand-picking your assets, your investments are usually in exchange-traded funds (ETFs), index funds or similar securities. While active management strives to beat benchmark performance, passive portfolio management looks to match it.

There’s much less risk involved in passive management, as you spread your money around to many different assets. That also means your potential return likely won’t be as high compared with active management, but you also won’t face as tumultuous of losses. You can expect lower costs with passive management compared with active management because there is usually less trading and oversight.

What does portfolio management entail?

When it comes to effective portfolio management, there are several key principles to keep in mind. These are generally the backbone of strategies professional portfolio managers employ.

Asset allocation

Asset allocation is the process of dividing your portfolio among many different types of assets or securities. This includes investments like stocks, bonds, mutual funds and others. Your asset allocation depends on the types of assets you’d like to invest in, when you plan to cash out — like retirement — and how risky you are as an investor. Not all types of assets will move up and down at the same time, so having a mix of many different types of assets can help balance your portfolio and protect against outsized losses.

Diversification

Diversification is about ensuring that you have a broad mix of assets in your portfolio — both among and within different asset classes — to reduce your risk. If you experience a drop in one asset, hopefully the rest of your investments won’t experience too much volatility that you’ll experience a major loss.

While it may seem tempting to put all of your money into one potentially lucrative stock or company, if that company fails you will lose all your money. Diversification spreads out your money among many different assets. This minimizes risk and lowers your chances of experiencing a huge loss when markets are down.

Rebalancing

Rebalancing is when you adjust your portfolio back to its original asset allocation mix. As your investments change, some assets will grow more than others. Similarly, some assets will drop more than others. Rebalancing is like realigning; you want to adjust every so often to make sure things are in the right place. You can rebalance every quarter, every year or when your assets change by a certain percentage; most people need to rebalance at least annually.

When you rebalance your portfolio, you’re looking at individual assets as well as your long-term investment goals. If your investment goals have changed over the last year, you’ll want to adjust your assets to match your goals as they currently are. Sell off investments that aren’t working for you, as long as you aren’t selling those assets at a loss. Look into buying new securities that are more in line with your ideal portfolio, but try not to buy when those investments are high. Adjust your contributions as needed.

Tax minimization

When you sell an investment, you may be taxed on those capital gains or dividends. While it’s very difficult to escape taxes, you can minimize the amount you’ll pay if you craft your portfolio correctly, and portfolio managers may keep this in mind when building your portfolio.

ETFs and index funds, for instance, are often managed with tax efficiency in mind. Some portfolio managers may also utilize tax loss harvesting, which uses investment losses to offset gains, helping to reduce your tax bill.

Tax minimization not only helps lower the amount you’ll owe in taxes right now, but in the future as well. Your investments could cost you if you aren’t minimizing your tax risk.

Using portfolio management investing techniques

If you’re handling your portfolio management, you’ll need some solid investing techniques to maximize your return. When it comes to how to build a portfolio, it depends on your goals, risk tolerance and investment timeline, as well as the process of evaluating your potential returns.

One of the most effective ways to manage your portfolio is through modern portfolio theory, a popular investing strategy that upholds the importance of diversification — when you spread your money across many different assets and securities — and the notion that the more risk you take, the more reward (and loss) you could face.

Here are some other portfolio management techniques to keep in mind as you build and manage your portfolio:

  • Set financial goals: These are the reasons you’re investing. This can be everything from getting ready for retirement, taking a vacation, saving for your child’s education, paying for your wedding or any other major financial goal. Once you determine your investment reason, you can set up a strategy to meet those goals.
  • Assess your risk tolerance: Be mindful of the type of investor you are. The more risk you are willing to take on, the potentially higher reward you’ll get (and the possibility for larger losses as well). If you’re a conservative investor, it might take you longer to reach your goals compared with an investor who takes more risk, but you also won’t be as vulnerable to potential losses.
  • Determine your timeline: Based on your goals and your risk tolerance, you’ll decide on a timeline to hit your target. Within your long-term goal, you’ll have short-term goals to hit. For instance, if you’re set to retire in 10 years, check in every year to make sure you’re on target. When you get closer to retirement, you’ll want to lower your risk to avoid major drops if the market takes a hit.
  • Calculate expected returns: To calculate your return, you’ll need to add up the weighted average of the rate of return for each security in your portfolio. Past performance and historic data is used to calculate expected returns, so it’s important to note that nothing is guaranteed, but guessed. You can usually find this data through your brokerage account, which typically details how an asset has performed in the past.

Do I need a portfolio manager?

Whether you need a portfolio manager depends largely on your financial situation and how much time you are willing and able to dedicate to the creation and oversight of your portfolio. For instance, if you have a lot of money to invest or your tax situation is complicated, a portfolio manager could be helpful.

Robo-advisors can be a great portfolio management for many people, as they generally have a low barrier to start investing and charge lower fees than traditional portfolio managers. However, robo-advisors generally offer passive management and a more limited selection of investments. If you are looking for a broader selection, want active management or have a more complicated financial situation, you might want to consider a traditional portfolio manager instead.

As you search for a portfolio manager, there a few things to keep in mind:

  • Account minimum requirement: Some firms have a minimum dollar amount to invest before you can get a portfolio manager. You’ll want to focus your search on firms with investment minimums that you can comfortably meet.
  • Education and expertise: Make sure you find a professional with the right education and expertise to manage your investments. For instance, many professionals might hold a certified investment management analyst (CIMA), certified financial planner (CFP) or chartered financial analyst (CFA) designations, all of which require advanced coursework and a certain level of experience to obtain.
  • Fees: Consider the management fees and how the costs of portfolio management will impact your total returns. Sometimes having a human manage your account as opposed to a robo-advisor might allow for active management and a greater level of customization, but you’ll also likely incur higher costs. You’ll have to weigh how important fees are toward your earnings.

Before selecting a portfolio manager, you’ll want to shop around and compare your options — after all, this is the person who will be managing your money to ideally help you make your financial goals a reality.