Financial Dictionary -> Investing -> Portfolio

Portfolios refer to a combination of investments which are held and managed by an institution or an individual. The purpose of such grouping of various assets (e.g. options, futures contracts, stocks, bonds, etc.) is to reduce the level of risk. The risk-limiting strategy which combines a large variety of investments is called diversification. A truly diversified portfolio can result in investment returns, even when some portions of the market are experiencing decline. In other words if you diversify enough, the positive performance of some investments will neutralize the negative performance of others. Different kinds of investments will yield higher returns and pose lower levels of risk. Therefore, good management of all the assets, contained within the portfolio, is vital.

In order to create an investment portfolio, one should gather adequate information about the instruments that will be included in the investment basket. The choice of assets, to be part of the product, generally depends on the level of risk associated with the expected return. Various assets are bundled depending on the investor's objectives. Asset allocation is typically a major factor in the attainment of investment goals while reduction of risk is associated with longer holding periods for the made investments. A conservative portfolio has just twenty percent invested in growth or growth income investments, forty percent in income-directed investments, and forty percent in stability of the principal. A moderately positioned portfolio carries an intermediate risk and return. An aggressive portfolio contains primarily equities or other high risk investments, aiming at aggressive growth, small scale companies, and international investments. To sum up, the greater the risk which the investors are willing to take, the higher the rate of return and vice versa.

According to the Modern Portfolio Theory (pioneered by Harry Markowitz in his paper "Portfolio Selection"), it is possible to establish an "efficient frontier" for optimal portfolios, yielding the maximal possible return at a certain risk level. Four baseline steps are involved while constructing a portfolio: security valuation, allocation of assets, portfolio optimization and finally, performance measurement.

Interestingly enough, Harry Browne, a free-market investment analyst, constructed the so called "permanent portfolio" which according to his understanding, represents a safe and profitable portfolio in any economic climate. Browne created the Permanent Portfolio Fund, which has a combination of assets similar to his theoretical portfolio. This fund averaged an annual return of 6.38 percent over a twenty five year period.

Multiple strategies for portfolio management exist, but two objectives are common to all investors: firstly, they aim at higher rates of return and secondly, they look for dependable and stable return which is not subjected to uncertainty.