Investment Portfolio

A Portfolio is nothing but the collection of investment instruments held by an individual or a company.

For e.g., An investment portfolio may include shares, mutual funds, gold, bank deposits etc.

Why do we need a Portfolio?

A portfolio is formed with an investment objective & investment horizon in mind and with an expected rate of returns. The investment horizon may range from a few months to even a few decades. The rate of returns would vary based on the individuals risk taking ability. Say for e.g., you may want to save up money for your retirement. In such a case your investment objective would be Retirement and investment horizon would be 20 years. A portfolio needs to be carefully planned and monitored constantly to ensure that our investment objectives are met within our investment horizon.

Risk Tolerance

Your Risk Tolerance is something that determines the instruments to be considered in your investment portfolio. Not everyone has the same risk tolerance level. If you are single and earning a handsome salary with no financial dependents, then your risk tolerance level is very high. If you are married and you have a wife and child dependent on you then your risk tolerance level is medium. If you are going to retire and would have to safe guard the money that you have saved so far then your risk tolerance level will be low.

Risk tolerance determines the instruments considered in your portfolio. A high risk investor may expose his portfolio heavily with equity products whereas a risk averse investor may expose his portfolio only to debt or other safe investment options.


Based on your risk tolerance level we can form 3 basic kinds of portfolios.

1. Aggressive Portfolio - For individuals with high risk tolerance
2. Balanced Portfolio - For individuals with average risk tolerance
3. Conservative Portfolio - For individuals with low risk tolerance

You have to decide in which category you would fall into. It is not mandatory to choose only these 3 portfolio's. You can opt to be somewhere between an aggressive and balanced portfolio wherein your investments would neither fall under aggressive category nor would they fall under balanced.

Your investment objective & horizon and risk taking ability would determine the kind of portfolio that would suit you.

Let us talk about the specialties of each portfolio and then we will try to form a portfolio for each category.

Aggressive Portfolio:

An aggressive portfolio is one that is designed to give us returns of at least 25-30% per annum. To provide such staggering returns we must have an extensive exposure to Equities (The Stock Market instruments - Shares & Mutual Funds) Equities have been able to provide a returns of around 30% or even more year after year. An ideal aggressive portfolio would invest about 70% of its portfolio worth in Equity related instruments. The remaining 30% would be invested in Debt instruments (Bank deposits, Bonds etc) & Gold.

Positives:

1. We can expect good returns on investment - at least 25% to 30% every year
2. If we begin early, then the power of compounding would work out in our favor and we would be sitting on a large saving when we are due for retirement

Negatives:

1. Since the equity exposure is around 75% the risk on investment is very high.

With the current market scenario people are not so confident about investing in equities. But this market slowdown is only temporary. In a few months time, the market would be back on its feet and once again equities would be providing us with the kind of returns that it has been providing us so far.

To know how to form an Aggressive Portfolio Click Here.

Note: In the current market scenario, expecting short term gains is not wise. Shares of some of India's greatest companies are available at great valuations. If we buy them now and build a solid portfolio, we are sure to make decent gains once the market is back to its bullish ways.

Balanced Portfolio:

A balanced portfolio is one that is designed to give us returns of around 15 to 20% per annum. A balanced portfolio would have 50% asset allocation in equity products and the remaining in debt products and gold. The strength of the balanced portfolio lies in the fact that, since we have a high debt allocation our investment corpus would not erode too much. The debt component would give us the balance and the equity component would help us gain the 15% returns on our investment.

Positives:

1. The debt component gives us a solid foundation to our portfolio.
2. The equity component gives us the higher returns
3. Comparatively less risky than Aggressive portfolio

Negatives:

1. The returns are only half of what an Aggressive portfolio would give us
2. With high levels of inflation in our economy, the returns from the debt market may not beat the inflation

To know how to form a Balanced Portfolio Click Here.

Conservative Portfolio:

A Conservative Portfolio is one that is designed with Capital Protection as the main priority. With debt instruments & gold comprising around 75% we are sure to preserve our capital. Since the equity exposure is also there we can expect marginally higher returns than what a fully debt oriented portfolio would give us. A returns of 10-15% can be expected out of a conservative portfolio.

Positives:

1. Our investment is safe. It may not rise too much but nor would it fall to give us losses
2. The marginal equity exposure would give us decent returns along with capital protection

Negatives:

1. The returns are even lesser than Balanced portfolio's
2. The returns may not even beat the market

To know how to form a Conservative Portfolio Click Here.

Managing your portfolio:

The first step would be to assess your risk tolerance level and then choose the kind of portfolio that would suit you. This is the easy part. Now comes the hard part "Maintaining the portfolio Balance"

Maintaining Portfolio Balance - is the series of actions you would have to do year after year to maintain your portfolio's balance. Let me explain with an example.

Say Mr. X invests Rs. 10,00,000/- in 2007 in an aggressive portfolio. Hence Rs. 700,000/- would be invested in Equities, Rs. 200,000/- would be invested in debt products and Rs. 100,000/- in gold.

Assuming equities are giving him a returns of 30% and debt a returns of 9% and gold 12% the current worth of his portfolio would be

Equities - 9,10,000
Debt - 2,18,000
Gold - 1,12,000

Net portfolio worth - 12,40,000/-

Hence the returns in the 1st year was 24% from his aggressive portfolio.

Since the equities gave him excellent returns Mr. X retained his equity investment as such and did not balance his portfolio to retain his original asset allocation.

This year in 2008 the equities have lost around 50% or more of their value but debt products have been able to give returns of about 11% and gold has given returns of around 15%. So at the end of 2008 what would be his portfolio worth?

Equities - 4,55,000
Debt - 2,41,980
Gold - 1,28,800

Net portfolio worth - 8,25,780/- which is a 33.5% loss when compared to the corpus at the end of 2007.

What if Mr. X had stuck to his original asset allocation of 70% equities, 20% debt and 5% gold? He would have withdrawn the excess investment from equities and distributed it across debt and gold.

Hence his asset allocation at the beginning of this year would have been

Equities - 8,68,000
Debt - 2,48,000
Gold - 1,24,000

And at the end of this year with the same kind of returns his worth would be:

Equities - 4,34,000
Debt - 2,75,280
Gold - 1,42,600

Net portfolio worth - 8,51,880/- which is a 31% loss when compared to the corpus at the end of 2007

Hence by realigning his portfolio to the original asset allocation Mr. X was able to avoid a loss of nearly 2.5% of his corpus which is Rs. 26,100/-

This is not a small amount of money. This example was just explained to illustrate the importance of maintaining the asset allocation. Once we form a portfolio and an asset allocation, we must stick to it until there is something severe that may warrant us to change it. For example with the ensuing credit crisis, bank stocks are the worst hit. At such a time we may want to reduce the allocation to banking sector. At the same time FMCG and Pharma stocks have been able to withstand the onslaught and even post growth in prices. We can reduce the allocation in banking sector and allocate that to these sectors.

Forming a Portfolio is not a one time activity. We have to constantly monitor the performance of our portfolio and realign it whenever necessary. A passively managed portfolio can never equal the returns of an actively managed portfolio.

Happy Investing...