Defined Portfolio

What Is a Defined Portfolio?

A defined portfolio is an investment trust that invests in a predefined set of bonds, stocks, or both that have been selected by the fund company. Similar to some classes of mutual funds, the trusts are closed-ended and not actively managed. Like a mutual fund, a closed-end fund is a pooled investment fund that has a manager overseeing the portfolio. It raises a fixed amount of capital through an initial public offering (IPO). The fund is then structured, listed, and traded like a stock on a stock exchange.

Key Takeaways:

  • A defined portfolio, or an investment trust, is an already defined group of bonds, stocks, or a combination of the two, that have been selected by the trust.
  • The trust's investments are closed-ended and not actively managed, similar to certain mutual funds.
  • With a defined portfolio, the securities are fixed, and units can only be sold after the completion of the initial buying phase.
  • Because the units have a specified shelf life, once that life has expired, the units are liquidated and the proceeds paid out to the investors.
  • While different kinds of securities can be used to build a diversified portfolio, stocks, bonds, and cash are the main components. 

Understanding a Defined Portfolio

Like other portfolio types, a defined portfolio is a collection of financial assets such as stocks, bonds, commodities, currencies, cash equivalents, and their fund counterparts, including mutual, exchange-traded, and closed funds. 

In a defined portfolio, the securities are fixed, and units can only be sold after the completion of the initial buying phase. These units tend to have a defined shelf life, after which they are liquidated, and the proceeds are returned to the investors. A defined portfolio can trade at different prices during the trading day.

Supply and demand determine the price of the units in a defined portfolio, which can lead to discrepancies in pricing from the net value of its underlying assets. Mutual funds can be out of sync with their net asset values but are only priced once per day at the net asset value as of the close of trading. Shares of stock from the portfolio are sold to investors by units.

Defined Portfolio and Risk Tolerance

An investment portfolio is divided into segments of varying sizes, representing a variety of asset classes and types of investment to accomplish an appropriate risk-return portfolio allocation. Many different types of securities can be used to build a diversified portfolio, but stocks, bonds, and cash are generally considered a portfolio's core building blocks.

The most prudent investors build investment portfolios that are in line with their risk tolerance and their objectives. Risk tolerance can be defined as the degree of variability in investment returns that an investor is willing to accept, especially when the market turns lower.

Special Considerations

Risk tolerance is one of the most important considerations when determining how to invest. Investors should have a realistic understanding of their ability and willingness to digest large movements in the value of their investments. If investors take on too much risk, they might be more inclined to sell amid a market downturn and miss out on a market rebound.

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