Portfolio Management Tips for Young Investors

Portfolio Management

Investopedia / Sydney Saporito

What Is Portfolio Management?

Too many young people either delay or forget entirely to invest for retirement. Some distant date that is 30 or 40 years in the future can be difficult to imagine, let alone care about today. And, without guaranteed pensions from employers and just a relatively small amount from Social Security, investments are often the best solution to supplement retirement income (if any), otherwise future retirees will often have a hard time paying for life's necessities.

One reason young people don't invest is they fail to understand stocks or basic concepts such as the diversification and the power of compounding. But it's not hard to learn. There are many sources of investing information, such as this website. Moreover, the earlier you start, the more time you have to build your wealth and ride out bear markets and periods of high volatility. Because of this, young people should get a leg up on portfolio management.

Portfolio management refers to the process of selecting and managing a set of investments that align with an individual's financial goals. The goal of portfolio management is to maximize expected returns while minimizing risk by holding a diverse range of assets. This process entails various strategies such as diversification, asset allocation, and risk management. The sooner you begin, the more time your investments will have to grow. Here we'll discuss some good ways to go aboutbuilding a portfolio and how to manage it for the best results.

What Is a Portfolio in Investing?

A portfolio is a collection of investments, which can consist of a variety of asset classes such as stocks, bonds, mutual funds, and exchange-traded funds (ETFs). The purpose of a portfolio is to achieve a balance between risk and return by selecting assets that are not highly correlated with one another, and which also align with an individual's financial goals.

The word "portfolio" comes from the Latin folium, meaning to "carry leaves" (as in papers). Stock and bond certificates were once only issued in paper form, from which this terminology was adopted. A portfolio is also used to describe an artist's collection of works, for similar reasoning.

Key Takeaways

  • Portfolio management involves investing in a variety of assets, such as stocks, bonds, and real estate, to reduce risk and maximize returns.
  • To start managing a portfolio, it's important to establish financial goals and risk tolerance and create a diversified mix of assets.
  • Regular monitoring and rebalancing of the portfolio can help maintain alignment with investment goals and risk tolerance.
  • Keeping costs to a minimum and considering the long term are important principles of successful portfolio management.
  • Seeking the help of a financial advisor or using a roboadvisor can provide professional guidance and expertise to build and manage a successful portfolio.

How to Build a Portfolio

When building a portfolio, it may be tempting to select stocks from companies that you are already familiar with, or which appear to be hot stocks in the media or online. However, this is not usually the best way to build a smart portfolio. Instead, seek out a wide range of stocks from different industries, and also diversify across different asset classes beyond stocks, such as bonds, real estate, commodities, and even a small allocation to cryptocurrency. Holding a variety of securities across different asset classes can help balance out the risks and returns of the portfolio, and help mitigate the impact of market downturns on any one particular investment or group of investments..

Building a portfolio involves several steps.

  • First, it's important to determine your investment goals. These can be segmented by time horizon, with long-term goals like retirement layered onto more medium-term goals like a down payment for a house or a child's college education.
  • Second, evaluate your risk tolerance -- from conservative to aggressive, or in between. This includes both your capacity to take on risk (which is related to things like your age, time horizon, income, and financial situation), and your willingness to take on risk.
  • Next, you'll need to select a mix of assets that align with your goals and risk tolerance. It is important to have a good degree of diversification, which involves selecting assets from different asset classes, industries, and regions to spread risk without sacrificing expected return. In general, a more aggressive risk tolerance will feature a greater allocation to stocks, while a more conservative portfolio will hold relatively more bonds and cash (see the example Figures below)
  • Once you have selected your assets, it's important to monitor and adjust your portfolio periodically. This involves rebalancing your portfolio to ensure it remains aligned with your investment goals and risk tolerance.
  • If your goals or circumstances change or evolve, you may have to return to step one and begin the process again.
Aggressive Portfolio

Image by Julie Bang © Investopedia 2019

Conservative Portfolio

Image by Julie Bang © Investopedia 2020

Some investors want to take an active role in managing their investments, while others prefer to simply set it and forget it. Your preference for portfolio management style may change, but decide on one approach to get started. For set-it-and-forget it types, "roboadvisors" are becoming an increasingly popular and cost-effective solution.

Why Diversification Is Key

You've heard the old adage "don't put all your eggs in one basket," and we've already mentioned that smart portfolio management involves diversification across asset classes and through holding a variety of securities within each one. This reduces the impact that any one asset or security will have on the overall portfolio.

The goal is to hold a range of securities that are not highly correlated with one another. When two assets are highly correlated, their prices tend to move in the same direction at the same time. For example, if you own two stocks in the same industry, their prices may rise and fall together based on the same industry-specific factors. On the other hand, holding assets that are not highly correlated means that their prices are less likely to move together, and may even move in opposite directions. This means that when one asset or security performs poorly, it is more likely to be balanced out by the positive performance of another asset or security. Thus, it is smart to hold to different asset classes as well as securities from a range of industries and geographic regions. Another way to diversify your portfolio is by investing in a mix of small, medium, and large companies. Often, larger companies have already achieved success, while smaller companies may be seen as more risky. However, smaller companies can also have greater potential for growth, which can help balance out the overall risk of the portfolio.

During an economic downturn, for instance, stocks may falter while bonds and gold might perform better. By holding a mix of assets across different asset classes, the losses in the stock portion of the portfolio may be balanced out by the gains in the bond and gold portions, reducing the overall impact of the market downturn on the portfolio.

An easy way to achieve good diversification, for beginners and seasoned investors alike, is to look to index mutual funds and ETFs that replicate broad asset class benchmarks like the S&P 500, Nasdaq 100, or the Aggregate Bond Index. Index funds provide this diversification at very low cost are readily available through a variety of fund providers - so building a portfolio around various index products can be a smart and cost-effective strategy.

It's important to remember that diversification does not eliminate risk altogether and losses can still occur; however, it can help reduce risk over the long term without sacrificing returns.

Why Is Portfolio Management Important?

Portfolio management is essential for achieving financial goals while minimizing risk. Without the proper planning and management, however, your portfolio can become unbalanced, subject to concentrated risks, and fail to meet your long-term goals. Winging it, following the crowd, going with your gut, or other types of uninformed portfolio construction can indeed be detrimental to your financial health.

A well-managed and diversified portfolio, on the other hand, can provide investors with higher returns and help them weather market downturns.

Because of its importance, it is often best to get an early start. Even if you don't feel comfortable opening a brokerage account right away, participate in your company's 401(k) retirement plan. If a 401(k) plan is not available through your employer, establish instead an Individual Retirement Account (IRA) and earmark a percentage of your monthly compensation for a contribution to the account. An easy, convenient way to save in an IRA or 401(k) is to create an automatic monthly cash contribution.

Another reason to start managing your portfolio right early on is that the younger you are, the less likely you are to have certain financial obligations yet, such as those related to a spouse, children, and a mortgage, to name a few. Without these expenses, you can allocate a portion of your investment portfolio to higher-risk investments, which can yield higher returns over the long run. You'll probably also have more cash available for investments and a longer time horizon before retirement during your younger years. With more money to invest for more years ahead of you, you'll be on your way to having financial security and a more comfortable retirement nest egg.

Best Practices for Portfolio Management

There are several best practices for portfolio management. Here are a few key strategies to keep in mind:

  1. Start with a plan: Before investing, it's important to establish your financial goals and risk tolerance. Take the time to think this through carefully, but also reflect and reconsider your goals from time to time as your personal circumstances change and evolve.
  2. Research your investments: If you are actively managing your portfolio by choosing what stocks and other securities will go into it, be sure to understand the assets and securities in your portfolio, including their risks and potential returns. Research potential investments before making a purchase and continue to stay informed about how your investments are performing over time. If you don't have the time or knowledge to do your own due diligence, look instead to index funds and ETFs or automated platforms like roboadvisors.
  3. Stay diversified: By investing in a mix of assets and securities, investors can reduce their exposure to any single asset or industry without sacrificing expected returns. Index funds and ETFs are an easy way to stay diversified, but pay attention to overlapping holdings that can undermine your efforts - for instance, if both the S&P 500 and Nasdaq 100 have Apple (AAPL) stock as a top holding, you're effectively doubling up on that stock and amplifying that risk.
  4. Monitor regularly and rebalance: It's important to periodically monitor and adjust your portfolio to ensure it remains aligned with your investment goals and risk tolerance. Your asset allocation will change naturally due to market fluctuations, such that if stocks rise and bonds fall, your portfolio's weighting to stocks will increase relative to bonds. Rebalance your portfolio by adjusting your stake in each category to restore your original weightings.
  5. Keep costs to a minimum: Management fees, trading commissions, and other costs can be a drag on your portfolio's performance. Luckily, today there are many online brokers offering zero-commission trading in most stocks and ETFs, and the expenses on ETFs and mutual funds have also come down considerably. Still, keep costs in mind and use strategies like tax-loss harvesting to minimize your tax bill.
  6. Consider the long term: Investing is a long-term game. It's important to maintain a disciplined approach and not be swayed by short-term market fluctuations that can trigger emotions like fear and greed. Make sure that you stay the course and put money into your investments on a regular, disciplined basis. This may not be possible if, for example, you lose your job of course, but once you find new employment continue to put money into your portfolio.

Keep in mind that no investment strategy is foolproof, and even the most carefully constructed portfolio can be impacted by unexpected events, recessions, or market disruptions. However, by following these best practices and maintaining a disciplined, long-term approach to investing, you can help maximize your chances of achieving your financial goals.

If you're new to investing or feel uncertain about your investment decisions, consider consulting with a financial advisor or opening an account at a roboadvisor. Both options can provide valuable advice and help you develop a personalized investment plan that aligns with your goals and risk tolerance.

What are the types of portfolio management?

There are various types of portfolio management that investors can use to optimize their portfolios based on their financial goals and risk tolerance. Active portfolio management involves regular buying and selling of securities to generate ongoing returns, while passive management involves holding on to a diversified mix of assets to track the performance of a benchmark index.

Another categorization of portfolio management is strategic asset allocation, which involves a long-term, buy-and-hold approach to investing with a focus on asset class diversification and risk management. This can be contrasted with tactical asset allocation, which is a more flexible, short-term, and reactionary approach that involves adjusting asset allocations in response to market trends or changes in macroeconomic conditions.

What is the main objective of portfolio management?

The primary goal of portfolio management is to allow investors to maximize their returns while minimizing their risks. This involves selecting a diversified mix of investments that align with the investor's financial goals and risk tolerance, and adjusting the portfolio over time to ensure it remains aligned with those goals. Effective portfolio management also involves monitoring the portfolio's performance and rebalancing it periodically to ensure it stays diversified and doesn't become too heavily concentrated in any one asset class or security.

What are the key elements of portfolio management?

The key elements of portfolio management include establishing financial goals and risk tolerance, selecting a mix of assets and securities that align with those goals, monitoring and adjusting the portfolio over time, and managing costs. It's also important to stay disciplined and focused on the long-term, avoiding emotional decisions based on short-term market fluctuations. Finally, investors should also minimize costs and consider the tax implications of their investments and use strategies like tax-loss harvesting to minimize their tax bill.

What should a well-diversified portfolio contain?

A well-diversified portfolio should contain a mix of assets and securities, including stocks, bonds, real estate, commodities, and other alternative investments. The exact mix will depend on the investor's financial goals, risk tolerance, and time horizon, but a balanced approach that includes both equities and fixed-income securities is generally recommended. Within each asset class, it's important to maintain additional diversification by holding a range of companies and industries, rather than concentrating on a few specific stocks or sectors.

The Bottom Line

Portfolio management is the process of selecting and managing investments that align with an individual's financial goals. The goal of portfolio management is to maximize expected returns while minimizing risk. To build a smart portfolio, one should seek to include a wide range of stocks from different industries, regions, and company sizes, and to diversify across different asset classes. It's important to first determine your long-term investment goals and evaluate your risk tolerance, and it is also important to monitor and adjust your portfolio periodically. Less hands-on investors can still achieve cost-effective portfolio management through financial advisors or algorithmic platforms such as roboadvisors.

Article Sources
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  1. Internal Revenue Service. "401(k) Plans."

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