Importance of Portfolio management in maximizing profits and limiting losses

Be it any activity, business or event, there is bound to be the probablity of a loss and thus, an inherent risk is always involved. The risk perceptions and risk taking ability vary from person to person and business to business. Although eliminating risk completely from one’s portfolio of investments is impossible, it can be controlled and brought down to reasonable limits by following a structured approach towards Portfolio Management. Frequently used as a synonym for asset allocation, Portfolios and the management thereof are one of the most commonly discussed topics in today’s academia and business.

Thanks to numerous recent corporate and financial failures (Barings Bank, the LTCM, the Russian default of 1998, Swissair, Enron, WorldCom, the sub prime crisis in the US and most recently, the global financial crisis), Investors are realizing the importance of managing and controlling their investment portfolios in a prudent manner. There are a variety of financial instruments available which can help in successful Portfolio Management. This paper aims at first understanding asset allocation and portfolio management.

It further goes on to define financial risks and then reviews all relevant literature available on the ways in which successful portfolio management enables an investor in maximizing returns and minimizing the risks involved. Based on the analysis of the literature, the paper has a set of recommendations, which can help Investors in drafting effective Portfolio Management strategies so that they too can tackle future crisis successfully. Introduction 1. 1 What is portfolio management?

A portfolio is defined as the sum total of all investments done by the same individual or corporate investor. The various asset classes include stocks ( buying a piece of a company); bonds ( principal is assured, rate of interest is pre determined and have a fixed maturity) and mutual funds ( a pool of money invested in capital market instruments by professional fund managers on behalf of the investors). Having a successful portfolio which stands the test of time is not an easy task though, since it should be designed based on an individual’s risk appetite and financial goals.

Thus, each individual will have a different portfolio suited to his needs. The world of investing, alas, doesn’t have any shortcuts. While designing a portfolio, three factors namely financial goals, risk appetite and time horizons are very important to be considered. It is these three factors which help an investor figure out how much money he would need at different stages of his life and how much volatility can an investor tolerate during various stages of his life.

Long term investments can afford to take a higher level of risk mainly because a temporary bull run will not cause havoc in the portfolio. Another feature of professionally managed portfolios is that they are constantly churned to maintain the pre-decided asset allocation. This is something that cannot be actively done in self-managed portfolios mainly because of a lack of time/ expertise and opportunity. A healthy portfolio must consistently shift from over-weighted areas of the portfolio to under-weighted ones, thus maintaining the pre-decided asset allocation at all times.

Portfolio management is an art. It involves decision making about the various investment options, matching financial goals and objectives to investments and balancing risk-return factors. Portfolio management involves doing a SWOT analysis of choosing debt or equity, growth or value investment style, flexible or fixed asset allocation and domestic and international investment options in order to maximize returns with minimal risks.