The Top Portfolio Management Strategies Investors Must Know

The Top Portfolio Management Strategies Investors Must Know

October 26, 2022

Making smart investment choices for your personal circumstances can have a tremendous impact on your ability to grow your wealth. But there’s no “one size fits all” approach to investing—not only do people have different goals and risk tolerances, but they also have different preferences about managing their investment portfolios. Understanding your options will help you determine the best fit for your situation.

In this article, we’ll explore a few portfolio management strategies that meet a range of investor objectives. We’ll also look at several management models (ways to implement the strategies) so you can decide whether you prefer a hands-on or hands-off approach to money management.

Looking for guidance on how to invest in a way that fits your risk tolerance level and future goals? Schedule a call with Bay Point Wealth’s team of financial experts.

First… assess your personal (investing) circumstances.

There are four crucial factors to consider about your situation before you can choose the portfolio management strategy that’s right for you:

  • Your objectives: Financial planning is integral to the investing process. You need to clearly understand your goals and big financial picture before employing any portfolio management strategies or models. This will help ensure the direction you choose will get you where you need to be.
  • Propensity for risk: Risk can make investors emotional, and everyone tolerates it differently. You need to know how comfortable you are with market volatility before you step onto the playing field.
  • Time horizon: Time typically bodes well for any investment. The longer you can keep your money in the stock market and ride out short-term disruptions, the more flexibility you’ll have to invest aggressively, if you desire.
  • Financial situation: If you don’t have much debt, and your need for cash in the short term is low because you don’t have any major expenses planned, you can probably afford to take more risks with your investments.

Now that you’ve read the fine print, let’s explore a few of the top portfolio management strategies and models.

3 Portfolio Management Strategies: Aggressive To Defensive

Aggressive Investing

In the world of investing, a higher risk is associated with greater returns. Aggressive portfolio management examples may include filling your portfolio with only stocks instead of bonds or buying stocks in up-and-coming companies whose returns are less predictable because they have a shorter track record in the market.

Aggressive portfolio management strategies are well suited to people with prior knowledge of investing, and whose long-term plans won’t be derailed by short-term variations in the market. These folks also tend to avoid watching the stock market closely.

For example, if you are young and in the “accumulation” phase of your life when you’re putting money aside for the future, an aggressive investment strategy could work for you. Most people who choose aggressive strategies are maxing out their retirement accounts or adding funds to their young children’s college accounts.

At this stage of life, retirement is so far away that a vision of your golden years—and crunching the numbers to figure out how to make it happen—hasn’t come into focus yet. Rather, saving whatever you can save is your main concern, since you won’t need the money until the long term based on your age. The phrase “long term” is relative, but when it comes to the stock market, it refers to at least 10 years if your money is invested aggressively. This is why an aggressive strategy isn’t advisable if you’re saving up for a short-term goal like buying your first home.

Aggressive investment strategies can help you build wealth, but they’ve also caused many investors to lose sleep at night, so be sure to consider your propensity for risk, time horizon, and financial situation before you purchase a high risk investment.

Pro Tip: Keep in mind that risk and return will always have a connection. The level of return you want your portfolio to generate will dictate how much risk you need to take with your portfolio management strategy.

The emotional aspect of investing bears repeating here because as human beings, we are all emotionally tied to our money. For example, you may feel strong emotions about your finances if you inherited your wealth. In this case, you may not be comfortable with a high-risk investment strategy—not because you need the money to support your lifestyle, but because you feel a sense of responsibility to the person who left it to you. This could cause you to invest more conservatively than is necessary.

In contrast, if you need to take more risk than you can tolerate because you haven't saved enough, the conversation with your investment advisor may then become about finding ways to save more money or extending your working years.

Defensive Investing

Defensive portfolio management models sit on the opposite side of the investing spectrum. Defensive portfolio management examples may include filling your portfolio with cash and bonds that have a more predictable investment experience, and that will better position you to achieve a specific rate of return within a set amount of time.

For example, if you experience a sudden and unexpected change in your life such as a serious medical diagnosis or the passing of a spouse, you may feel more secure pursuing a defensive investment strategy for the time being while you get your feet back under you. In contrast to individuals in the accumulation phase of life, defensive strategies are best for those who are withdrawing their money and who don’t want to take a lot of risk. Of course, any investment will fluctuate in value because it’s not cash, and there is no guaranteed return; however, defensive portfolio management strategies will see less fluctuation than other approaches, particularly in the current market.

It’s important to note that the decision of whether or not to build a defensive investment portfolio should never be based on your opinion of the economy or short-term stock market direction. In other words, don’t panic and change your strategy in a year like 2022! Rather, the decision must always be made based on what best suits your needs, given your personal financial and life circumstances.

Investors who want or need more stability in their portfolios, as well as to have a clearer picture of what their investment experience will look like, would be wise to consider defensive strategies. If your time horizon is shorter or if your financial plan includes a large expense in the short term, defensive portfolio management strategies are also a smart choice. Just keep in mind that with this strategy, your returns may not be as high as with the former.

Balanced Investing

Most investors fall in the middle of the spectrum. Balanced portfolio management strategies are a good fit for people who want the opportunity to receive some returns to meet their long-term financial goals, but who also have a few short-term financial obligations, so they don’t want to run the risk of ruin.

While the word balanced can mean different things to different people, it often refers to a portfolio that is made up of 60% stocks and 40% equities or a 50/50 split. Typically, you’d look for a portfolio of this nature to generate a 5-7% return on average over time.

A balanced portfolio will hold more aggressive investments in the accounts you'd withdraw your money from last—for example, a Roth IRA. The portfolio will also contain cash and more conservative investments from which you'll pull income.

Many individuals get started with a balanced portfolio in their 40s or 50s when they’re thinking more about retirement and their sources of income after they stop working. In addition, you can remain in a balanced portfolio for the rest of your life. If you're withdrawing money from the portfolio, and the portfolio is producing enough income to outpace inflation, you’ll be sitting pretty.

3 Portfolio Management Models: Active To Passive

Active Investment Management

Once you've decided where you fit on the aggressive to defensive-investing spectrum, it’s time to think about how you want to manage your portfolio. Active portfolio management models involve paying analysts to oversee your portfolio, decide which stocks to hold and which not to hold, consider how much risk to take and buy and sell accordingly.

The value proposition of this strategy is that despite the added costs associated with active money management in terms of person-hours, portfolio managers believe they can provide a return above and beyond what you’d otherwise receive without working with them.

In reality, reports such as the SPIVA Scorecard* have shown that many portfolio managers do not outperform the returns on passive investments such as index funds, which we’ll discuss next. This doesn’t mean you shouldn’t consider an active approach—it simply means you need to have realistic expectations about active portfolio management strategies.

*According to S&P Global, the SPIVA scorecard is a semiannual report published by S&P Dow Jones Indices. The report “compare[s] the performance of active equity and fixed income mutual funds against their benchmarks over different time horizons.”

Passive Investment Management

Passive portfolio management models emerged about 40 years ago from the debate around active money management’s effectiveness. For example, index investing involves aiming to replicate the performance of a broad market index (such as the S&P 500), and enables investors to avoid the added costs associated with active management.

If you prefer that markets do the work, and wish to mitigate the impact of higher management fees and taxes, you may lean toward an index style of investing.

Factor-based Investment Management

This investment strategy (also known as smart beta investing) started in the 1960s with academics trying to understand what exactly drives market returns, and whether they could use that information to help drive investment decisions. The research took off in the 80s and 90s, and institutional investors began to implement it once they found that certain characteristics of stocks perform well over long periods of time.

For example, small company stocks tend to outperform their large company counterparts. Knowing this, factor-based investment advisors may decide to own more smaller company stocks to a portfolio in a manner that’s diversified. Because they don’t have to understand the nuances of each company, factor-based advisors can deliver this type of investment management in a cost-effective and tax-efficient way. Of course, there are no free trade-offs in investing, so there will inevitably be time periods where the investments in your smart beta fund aren't doing so hot.

Ultimately, if you believe wholeheartedly that active money managers can deliver the best returns, that should be your strategy. If you feel the exact opposite, you should probably focus on index investing. If you prefer a more academic, evidence-based investment strategy, and you don't want to just buy and hold investments, but you don't necessarily want to have a concentrated stock position, then factor-based investment management is likely your best bet.

A Final Element To Consider: Diversification Of Investments

The idea here goes back to the old saying that you shouldn’t put all your eggs in one basket. Diversified portfolio management strategies aim to ensure that the success of your portfolio isn't contingent on the performance of one investment. Diversification doesn't prevent losses, and it won't get you the highest gains, but it will smooth out some of the rough edges of your investment experience.

The more you diversify your portfolio, the more you minimize company-specific risks. For example, if your portfolio includes numerous dividend companies, the fact that Disney had to suspend its dividend recently wouldn’t have had a large impact on your portfolio. If, on the other hand, Disney was one of only five stocks in your portfolio, it would have had a dramatic impact.

The other aspect of diversification is the idea of correlation—how investments operate in tandem. If your investments are positively correlated, they’ll work in lock step. If they're negatively correlated, they’ll work in opposition. For example, if another event causes a huge drawdown in equities like the COVID-19 pandemic did, and you have fixed income in your portfolio that isn’t correlated with stocks and therefore isn't down, that will help soften the blow.

Pro tip on diversification: It's easy to become concerned about the investments in your portfolio that you feel aren’t contributing, but they oftentimes do serve a purpose. If your portfolio was well-crafted, every investment is there for a reason. It’s best to look at your portfolio as a whole versus its individual constituents. Think of it like a symphony—you may not like the sound of horns, but they’re necessary for the symphony to work together.

A Professional Investment Strategy Designed Just For You

If you’re feeling overwhelmed by the breadth of investment strategies and options on the market (pun intended), our advisors can help. With thoughtful guidance, you can make smart decisions about which stocks and bonds to invest in, what kinds of investments to include in your portfolio, and what level of risk to take to ensure you reach your goals.

At Bay Point Wealth, we’ll work with you to understand your needs, and your big picture financial plan will be at the center of all our investment conversations. We’ll focus on what we can control and stay the course—without trying to “beat the market.”

Schedule a call with us today to get started.