Portfolio Management and Diversification

PORTFOLIO MANAGEMENT AND DIVERSIFICATION

Introduction:

Portfolio management is a conglomeration of securities as whole, rather than unrelated

individual holdings. Portfolio management stresses the selection of securities for

inclusion in the portfolio based on that security's contribution to the portfolio as a

whole. This purposes that there some synergy or some interaction among the securities

results in the total portfolio effect being something more than the sum of its parts.

When the securities are combined in a portfolio, the return on the portfolio will be an

average of the returns of the securities in the portfolio. For example, if a portfolio

was comprised on equal positions in two securities, whose returns are 15% and 20%, the

return on the portfolio, will the average of the returns of the two securities in the

portfolio, or 17.5%. From this we will discuss the process of creating a diversified

portfolio. The diversified portfolio is a theory of investing that reduces the risk of

losing all your money when "all your eggs" are not in one basket. Diversification limits

your risk an over the long run, can improve your total returns. This is achieved by

putting assets in several categories of investments.

Portfolio Process:

The portfolio process is as follows:

1. Designing an investment objective;

2. Developing and implementing an asset mix;

3. Monitoring the economy and the markets;

4. Adjusting the portfolio and measuring the performance

Due to the intensity of each of the four items, we will be covering only the first two.

1. Investment Objective:

This topic is broad and contains three major divisions. They are foundation objectives,

constraints and major objectives.

Foundation Objectives: These objectives generally receive the most attention from

investors and are determined by thorough determination of your needs, preferences and

resources.

- Return - you need to determine whether you prefer a strategy of return maximization,

where assets are invested to make the greatest return possible while staying within the

risk tolerance level, or whether a required minimum return with certainty is preferable,

generating only as much return with emphasis on risk reduction.

- Risk - There are many ways to assess the risk tolerance of any particular investor,

from the least knowledgeable of investments to the very sophisticated investor. Besides

the risk you are willing to take, there must be a measure of the risk associated with

each security be considered for the inclusion in the portfolio. It is important to

recognize the difference between the risk of an individual security and the risk of the

portfolio as a whole. The risk of a portfolio is less than the average risk of its

holdings, your risk tolerance should be matched to the risk of the overall portfolio and

not to the risk of each security.

- Inflation - Although some degree of inflation protection is needed, the extent will

vary depending upon the time horizon and the goal of using the portfolio to generate

income for future cash consideration. Whereas, someone using a short term trading

strategy and interested in maximization of capital gains may concentrate less on this

factor.

- Time Horizon - The time horizon is the period of