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Portfolio Management Customization
Portfolio management involves building and overseeing a selection of investments that will meet the long-term financial goals and risk tolerance of an investor.
Active portfolio management requires strategically buying and selling stocks and other assets in an effort to beat the broader market.
Investors who implement an active management approach use fund managers or brokers to buy and sell stocks in an attempt to outperform a specific index, such as the Standard & Poor's 500 Index or the Russell 1000 Index.
An actively managed investment fund has an individual portfolio manager, co-managers, or a team of managers actively making investment decisions for the fund. The success of an actively managed fund depends on a combination of in-depth research, market forecasting, and the expertise of the portfolio manager or management team.
Portfolio managers engaged in active investing pay close attention to market trends, shifts in the economy, changes to the political landscape, and news that affects companies.
Passive portfolio management seeks to match the returns of the market by mimicking the makeup of a particular index or indexes.
Passive portfolio management, also referred to as index fund management, aims to duplicate the return of a particular market index or benchmark. Managers buy the same stocks that are listed on the index, using the same weighting that they represent in the index.
A passive strategy portfolio can be structured as an exchange-traded fund (ETF), a mutual fund, or a unit investment trust. Index funds are branded as passively managed because each has a portfolio manager whose job is to replicate the index rather than select the assets purchased or sold.
The management fees assessed on passive portfolios or funds are typically far lower than active management strategies.
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Key Elements of Portfolio Management
The key to effective portfolio management is the long-term mix of assets. Generally, that means stocks, bonds, and "cash" such as certificates of deposit. There are others, often referred to as alternative investments, such as real estate, commodities, and derivatives.
Asset allocation is based on the understanding that different types of assets do not move in concert, and some are more volatile than others. A mix of assets provides balance and protects against risk.
The only certainty in investing is that it is impossible to consistently predict winners and losers. The prudent approach is to create a basket of investments that provides broad exposure within an asset class.
Diversification is spreading risk and reward within an asset class. Because it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of all the sectors over time while reducing volatility at any given time. Real diversification is made across various classes of securities, sectors of the economy, and geographical regions.
Rebalancing is used to return a portfolio to its original target allocation at regular intervals, usually annually. This is done to reinstate the original asset mix when the movements of the markets force it out of kilter.
For example, a portfolio that starts out with a 70% equity and 30% fixed-income allocation could, after an extended market rally, shift to an 80/20 allocation. The investor has made a good profit, but the portfolio now has more risk than the investor can tolerate. Rebalancing generally involves selling high-priced securities and putting that money to work in lower-priced and out-of-favor securities.
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