What goes into effective portfolio management?

With the costs and restrictions of a traditional portfolio manager, it can be tempting to avoid fees and be in greater control of your money by managing a portfolio yourself. In theory, you could imitate a target portfolio when you first set up the portfolio. But given the expertise and time required, it’s not as straightforward to maintain the portfolio as it may seem.

Here are 4 things to consider when evaluating how to manage your investments, from asset allocation and risk management, to time and costs required.

Spoiler alert: Investing on your own might not save you as much as you think it would.

1. Asset allocation and diversification strategies

It takes experience and knowledge to build different types of portfolios, which involves effective asset allocation and diversification. And not all portfolios are created and managed similarly, as a portfolio's composition and management strategy depends on the amount of money you’re trying to earn, against your given timeline and preferred level of risk.

For example, a long-term retirement portfolio will have different investment parameters and risk levels compared to a short-term wedding savings fund.

A good portfolio manager will make sure your investments are diversified to increase the chances of return for each portfolio.

Multi-asset portfolios increases the chance of better returns

Asset allocation is the strategy of dividing an investment portfolio into different asset classes and subclasses to achieve the highest expected returns for the given level of risk the investor is willing to take. Several long-term studies have concluded that asset allocation is responsible for 80% to 96% of a portfolio’s total return.

Determining the asset allocation of a given portfolio requires you to assess market, economic, and external variables, and how they correlate to each other in both the short and long term.

Properly diversified investments minimise risk

Diversification minimises concentration risk by spreading investments across a large number of securities across asset classes or market segments that exhibit similar risk and return trade-off profiles.

To illustrate, let’s consider the difference between investing all of your funds into Apple shares versus a portfolio of 30 technology stocks. In the first case, an investor is fully exposed to any events relating to Apple (stock splits, earnings surprises, new products announcements, and so on). In the latter case, the investor is significantly less exposed to company-specific risks. The level of diversification therefore minimises volatility and unnecessary risk.

2. Risk management expertise

Setting up the right asset allocation and applying optimal diversification is key, but managing a portfolio also requires managing risk throughout market and economic changes that affect the asset allocation.

Rebalancing and re-optimising your portfolio to manage risk exposure

In the inevitable case that market and economic activities compromise your original asset allocation, it’s critical to rebalance your portfolio back to its target asset allocation.

Rebalancing is a function of quantifying and monitoring the portfolio’s exposure to risk, and making sure that you maintain the intended balance of risk and returns in a given portfolio by trading securities when appropriate.

Knowing what to buy and sell to return the asset allocation back to its target is not always straightforward. For example:

• If you had 14% of your portfolio allocated to small cap equities, do you know how much you should trade to maximise your returns while maintaining your target level of risk?
• And if, due to changing market conditions, small cap equities grew to 20% of your portfolio, would you know which assets to buy and sell to get back to your target allocation?

Knowing when to sell might be even more important than knowing what to sell. Seasoned, technology-savvy investors know that rebalancing whenever there is a slight change in the portfolio’s allocation isn’t practical, and instead have automated models that help make the right decision at the right time.

In the case of major economic cycle shifts, a portfolio manager will actually make significant changes to the portfolio’s target allocation, known as re-optimising a portfolio, to address the new conditions that impact a portfolio’s exposure to risk and return.

It takes expertise, extensive number crunching, and advanced technology to first recognise the economic shift, and then to make the appropriate changes at the right time.

3. Cost management

There are costs associated with investing that are worth reducing wherever possible, as costs directly impact returns. Despite charging management fees, portfolio managers are often able to achieve cost efficiencies that individual investors are not always able to achieve.

Investment tools increase efficiencies

As an individual investor, you’ll likely face minimum trade amounts that a manager does not necessarily have. This can be limiting when trying to deploy a certain investment strategy.

An upside of employing a portfolio manager is that they have access to tools to rebalance and buy fractional shares, which are not readily available to the general public. This allows them to execute trades that are more precise to their investment strategies.

Transaction fees are less expensive in bulk trading

Brokers for individual investors often charge per trade. Let's say your broker charges a minimum of $10 USD per trade, and you want to invest in a diversified set of 10 ETFs each month. This means that you will be spending a minimum of $100 USD/month just on trades. As a percentage of your investments, this amount will be 10% of your investments if you invest $1,000 USD/month, and less than 1% only if you invest more than $10,000 USD/month.

By investing on your own, you are liable to much higher transaction fees than if you were to compare it to the percentage fees charged by portfolio managers, that can range from 0.5% up to 2.0-3.0% per annum. Institutions can negotiate better trading rates with their brokerage partners, therefore minimising costs.

Because they are managing numerous portfolios, portfolio managers have access to buy and sell in bulk, and don’t face 'per trade' costs with their brokers.

Foreign exchange rates and bank transfer fees hurt returns

Brokers will typically charge a percentage of your assets in the case that you wish to invest in a security, other than futures contracts, that is in a different currency denomination than the cash you hold in your account. On top of that, you could be hit by additional fees if you transfer from your local account to an international broker account. For example, if you have AED that you want to use to invest in an ETF that is in USD, you will be charged a foreign exchange rate in addition to the transaction and bank transfer fee.

Typical transfer fees for USD range anywhere from $35 USD to $75 USD per transfer. If you were to transfer funds once per month, over a year this could cost you anywhere from $420 USD to $900 USD in bank transfer fees alone. This could significantly mitigate your returns, especially as this amount won't have the opportunity to compound and grow over time.

4. Time commitment

It takes time and expertise to analyse the markets and the economy. If you lack the time or knowledge required to assess the dynamics that affect your investments, you could miss out on opportunities to re-optimise your portfolio. This is a common challenge for those who work full-time and can’t dedicate a few hours per day to portfolio management.

A portfolio manager who is trained in reading the market and economy will be able to re-optimise your portfolio for you. They will also build an investment strategy based on regular monthly deposits - so you’ll be able to stay on track with your investments even when life’s distractions get in the way.

Weigh your options carefully

Now you know what goes into effective portfolio management, you’ll need to weigh your options carefully.

Asset allocation strategies and your approach to risk management can impact your investment returns. You'll also need to consider the time and costs required when deciding from different wealth management options.

We created StashAway to overcome these restrictions and increase accessibility to technology-driven investment solutions. We offer low management fees, so that you have flexibility with your investments, and can reach your investment targets more easily. That means you can set your goals and deposits easily, while letting us do the rest.

Manage your wealth with StashAway