- There are two main types of portfolios constructed: actively managed portfolios and passively managed portfolios. Active portfolios use funds (typically mutual funds or ETFs) that are managed by a discretionary manager who selects securities for the fund. Passive funds are typically index funds. These funds invest in a given set of securities--for example, all of the stocks in the S&P 500. These funds make no trades except to keep the 500 stocks in the right proportions and amounts. Selecting between active and passive management, or a mix of both, is the first portfolio guideline that must be established by an investor.
- The investment objective, time horizon for tapping the funds, and liquidity needs all affect the risk tolerance of the investment portfolio. For investors who need highly liquid funds and have a short time horizon, a larger allocation must be made to fixed income investments and cash equivalents. For investors with long time horizons and an objective of capital growth, riskier assets such as international stocks, small cap stocks and REITs become appropriate.
- All investment allocations require taking on some risk. Every portfolio should have guidelines on how to take appropriate risks that are adequately compensated for while avoiding unnecessary or uncompensated risks. Typically the biggest risk management technique investors can utilize in their portfolios is diversification. Ensuring that the portfolio is made up of a large number of investments limits the potential impact that one security can have on the entire portfolio.
Active vs. Passive Investing
Risk Tolerance
Risk Management
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