Definition: A portfolio investment is a strategic composition of securities, bonds, debt funds and other financial instruments with the view of making returns or value enhancement of the funds invested. An investor can self-design an investment portfolio or can get it done from a portfolio manager.
Sticking a single stock appears to be a perilous decision while the same amount can be systematically divided into different financial assets. Thus, when some of these financial instruments are in loss, the investor would be on a safer side because of the profits earned from the remaining.
Content: Portfolio Investment
- Components
- Factors
- Types
- Advantages
- Disadvantages
- Example
Components of Portfolio Investment
What all asset options do an investor has?
We are listing out the standard forms of assets available for the investors to include in their portfolio:
Cash: An investor can invest in the money market by procuring short-term bonds whose maturity is within 90 days.
Cash Equivalents: This is another short-term investment opportunity where the investor can buy commercial paper (CP), treasury bill, certificate of deposit (CD), etc.
Bonds: A bond is a form of credit taken by the government, agency or company from the public for a long-term. This investor receives interest periodically and the principal amount on the maturity date.
Stocks: An investor can enjoy a small share of any company’s ownership by the means of buying its stocks.
Exchange-Traded Funds (ETFs): The ETF is a bunch of different securities, bonds and other instruments following their underlying index.
Mutual Funds: An investment providing the opportunity to any small investors to come together and buy a financial asset comprising of different securities, money market instruments, bonds and others.
Real Estate Investment Trusts (REITs): REITs is investing in the stocks of the companies which function in the real estate sector or possess a variety of properties like housing or buildings, shopping complex, hospitals, theme park, etc.
Alternative Investments: These are promising assets whose value can augment remarkably in the long run. For instance: gold.
Factors Affecting Asset Allocation in Portfolio
What all aspects a portfolio manager or an investor consider while selecting the assets for an investment portfolio?
The following determinants frame such asset allocation decisions:
Investment Objective: Every investor has a vision or aims for saving or investing the excess money in the long run. Some invest for life after retirement, some for child’s future while others may have dreams of owning a house.
Fund Available: An investor first allocates his/her income to meet the expenses and then plans to invest the remaining amount. The person chooses the assets according to his/her purchasing power.
Investor’s Age: A young investor is aspirant and has an extended investment period in comparison to an old aged investor. Thus, the prior can pool more funds in equity while the latter seeks stability by acquiring bonds and debt funds.
Investor’s Risk Bearing Capacity: The investor’s capacity to face the uncertainty determines the kind of instruments in his/her investment portfolio. If a person highly risks tolerant, the portfolio consists more of equity funds; if he/she decides to play safe, the fund is mostly put into the debt funds or bonds.
Investment Duration: The time frame for which the investor plans to keep the funds engaged also affect the asset selection. If the investor is looking for a long-term opportunity (at least 10 years), then even the high-risk equity funds can do wonders. However, if the investment span is short (say 5-10 years), secured funds like bonds are procured.
Types of Portfolio Investment
An investment portfolio is known by the kind of assets it consists of. Let us elaborate on the various kinds of a portfolio which an investor can opt:
- Income Portfolio: Such a portfolio includes more dividend-paying instruments since the investor aims to get regular returns.
- Growth Portfolio: The investors targeting the value enhancement of their holdings go for growth portfolios. Here, the major securities are of the companies which are at their growing stage.
- Speculative Portfolio: In this type of investment portfolio, the investor keeps an eagle’s eye over the market to grab instant opportunities, thus the risk level is highest and so can be the profit.
- Value Portfolio: A value portfolio is made up of the securities which are though promising but available at a cheap price today. Thus, future gains are supposed to be quite high from such an investment.
- Aggressive Portfolio: When an investor creates a portfolio comprising of high-risk investments to make colossal profits, it is termed as an aggressive portfolio.
- Defensive Portfolio: The investors sometimes prefer to invest in stable stocks i.e., in the companies which are least impacted by the market volatility and economic downturns.
- Balanced Portfolio: The portfolio having a perfect combination of the securities and bonds is called a balanced portfolio.
- Retirement-Blended Portfolio: Such a portfolio comprises of government bonds, debt funds and other stable instruments to ensure a constant return after the investor’s retirement.
- Hybrid Portfolio: This one is kind of a varied portfolio with a blend of stocks, bonds and other instruments. A hybrid portfolio diversifies the asset allocation extensively.
Advantages of Portfolio Investment
Portfolio investment is a widely considered opportunity by all kind of investors, be it individuals or corporates.
Let’s understand the benefits it has to these investors:
- Long-term Gains: If the investor consistently, smartly and patiently invests his funds, he/she would surely benefit from it in future.
- Diversification: Portfolio investment is a great idea to own more than one asset and minimize the risk of loss from investing in a single instrument.
- Limited Management: The portfolio manager or the investor need not to regularly track the asset performance as done in trading. Instead, a strategic approach is adopted to make a profit over a long period.
- Attainment of Objective: An investor can accomplish his/her vision or life goals by having a well-managed investment portfolio and holding on to it for a long duration.
- Suits Investor’s Risk Profile: We can say that portfolio investment is customized to the risk appetite of an investor; also it can be modified at any point in time.
- Provides Dividend or Growth Opportunity: The investor can either seek dividend on securities or upsurge in the fund value; both the conditions are profitable.
Disadvantages of Portfolio Investment
There are certain limitations of portfolio investment which makes it unfavourable at times. Some prominent ones out of these are discussed below:
- mproper Research Results in Loss: If an investor or a portfolio manager doesn’t gain sufficient knowledge about an asset and its performance over an extended period, the risk of failure hikes up.
- Requires Basic Financial Knowledge: Whether an investor hires a portfolio manager or not, he/she needs to be aware of the financial fundamentals for avoiding fraud or uncertainties.
- Uncertainty: Every instrument or financial asset bears a tag declaring its vulnerability to market risk or failures.
- Inefficiency of Investment Companies: Sometimes, the investment company where the funds are pooled in, faces downfall or even shut down, leaving the investors at loss.
- Selection of a Wrong Portfolio Manager: A less experienced or senseless portfolio manager can spoil the game.
Example
Mr A is of 30 years and wants to become super-rich from his limited savings. He is ready to take excessive risk and the investment period is 20 years.
The portfolio manager designs an aggressive portfolio for him. It has 80% of securities such as emerging-market stocks and 20% of bonds.