Manage your Portfolio in 5 steps

Creating wealth in the stock market requires a systematic disciplined approach. And systematic approach can be built into the process of your portfolio management. Success at trading or investing comes with structured practice and by employing developmental process to improve your performance. Keeping track of your losses, gains, comments and lessons will help you evolve as a better trader at stock market. If your portfolio management can adhere to a structured and a self-evolving process, then not only will you create wealth but you will become good at it. You will discover that portfolio management will be a vital skill in doing so.

Step 1: Defining your goals and your Risk Tolerance

Assess your personal financial situation and determine your investment goals. State the purpose of your investing, how long do you have to achieve the goal, how much money can you invest and how much money will you need. You will have to be realistic with your goals. If you set yourself a very lofty goal, then you will soon realize that you have readjust your goal later. I recommend that you set your goal higher since that will provide you a better challenge to work with.

Another personal decision you want to make is to understand your risk tolerance level. You will have to come up with the risk tolerance that you have to work with based on your personality and your financial situation. This will ensure that you can stomach the portfolio fluctuations and will be able to sleep better at night.

Apart from your personal goals, every portfolio will have its general goals; like generating higher returns, reducing risks and managing risks better.

One of the primary goals of portfolio management is to provide consistent returns over time. One or two successes at market can provide you some money, but it cannot create wealth in the long run. As stated in this article, sustained consistent returns of portfolio is very important. Because for the same annual average percentage, a portfolio with consistent performance yields higher returns than a portfolio with performance fluctuation.

In order to achieve consistently high performance, you need to pay attention to your portfolio regularly. Even if it is your retirement fund and retirement is far away, review it every quarter and make sure the portfolio is on track to achieve consistent growth. Sometimes your portfolio is exhibiting fluctuations because you might have taken on more risk to generate higher returns. A good tool that can be used to measure the extra risk in the portfolio is Sharpe Ratio. Sharpe Ratio also tells you if the portfolio returns are due to smart investment decisions or due to the extra investment risk. While reviewing your portfolio, rearrange the investments to maintain a higher sharpe ratio so that your portfolio is subjected to minimum risk for the rewards expected.

Another important goal of Portfolio management is to manage the inherent risks of investing. This article on risk management of portfolio discusses the basics behind mitigating investment risks. These techniques are built into this current process of portfolio management.

Step 2: Determining Asset Allocation:

Based on your risk tolerance, you can build adequate level of aggressiveness in your portfolio to generate enough returns. This is achieved through proper asset allocation. The beauty of Asset allocation is that it personalizes the returns and risks for each individual. When the goal is to achieve higher returns with higher risk, you can opt for an aggressive portfolio. But when you desire preservation of value, then build a conservative portfolio. This "How to build a robust portfolio" article illustrates with an example about the three important decisions to be made during asset allocation.

Another important concept behind reducing performance fluctuation is Diversification. Some of the asset classes exhibits low correlation with each other's performances. For example, bonds might show stability when stock prices are declining. When diversification is employed in the portfolio, the overall portfolio stability and performance improves. Consider allocating your resources to different sectors of the economy.

Step 3: Implementing the Portfolio:

The article portfolio building provides attributes/characteristics of each asset class and its correlation with respect to other classes. Bring in appropriate asset classes to be in commensurate with your asset allocation. The next important step is to select each individual security for each asset class. Whether you are selecting a stock, or a bond, or a certificate of deposit, or a structured debt investment, selecting a security requires deliberate planning to ensure that they fit your portfolio goals. This article describes how to invest in Mutual Funds for your portfolio. Exchange Traded Funds (ETFs) have become popular these days and this article can help you understand if ETFs can belong in your portfolio and how ETFs can be advantageous.

Consider diversifying your assets even within each asset class. For example, stocks or mutual funds can be diversified into large cap or small cap, or into growth or value funds. Similarly Bonds can be diversified into Government or Corporate bonds, or into short term or long term bonds. When you are putting money into each of the securities, it is important to decide how much money to put in each stock or fund or bond. Sizing each position is essential to ensure that you are not wiping out all your money in one single trade. There are some interesting Position Sizing techniques discussed in this article.

Step 4: Re-balance and Re-allocate strategically:

Portfolio management is an on-going task. You set it up the first time and over time the proportion of Asset allocation drifts from its original allocation. It can be very tempting to let the portfolio run without changes (Eg; when stocks are doing very well compared to bonds), but in order to reach your original goals you will have to re-balance the securities to bring back original asset allocation. This interesting article that describes how to re-balance your portfolio and how re-balancing improves the performance.

Re-balancing the portfolio can involve selling of securities and selling securities can have tax implications. When it is possible you can stop investing in a security instead of selling since this can avoid you the capital gains taxes from selling.

Selecting a security or removing a security from the portfolio is a process that needs to be done frequently because the relevance of a security to your portfolio can change with time (due to economic changes and due to change in your individual circumstances). And you might find that a security might not be serving any good purpose in your portfolio.

Sometimes it is possible to speculate that certain sectors of the economy can do well. For example, low cap stocks thrive during low interest rate and large caps do well during higher interest rate scenario. If you can re-allocate your securities even before the interest rate moves higher, then it is possible to improve your performance. So consider the outlook for different securities before you re-allocate since this can provide you with some extra returns.

Step 5: Re-assess your situation:

With time your personal financial situation might change or your future needs might change or your risk tolerance might change. When one of these changes happen, it might be appropriate to change the proportionate allocation of assets. For example, your portfolio could be aggressive when you were in earlier part of your career, but as move closer towards your retirement you would want to change the allocation to a conservative one. This kind of change is the gradual evolving of portfolio to meet your needs over time.

Summary:

A well diversified portfolio that has its assets allocated in proportion to your personal financial situation is your best bet for consistent growth for long haul. When you make appropriate re-balances and readjustments, you will have a greater chance of meeting your financial goals.