Portfolio Management – A Step by Step Guide

Portfolio Management, which ideally should be part of everybody’s regular – if not routine life – sadly has become a fancy term, first mention of which invites responses ranging from reluctant to scary. A number of reasons can be attributed for the same like absolute absence of financial education in school and college curriculum, relative immaturity of Indian financial industry, low level of literacy, bad legacy of certain products and constraints on marketing and promotion of financial products by Indian regulators.

In my last article I dwelt upon the importance of financial planning, lets use this opportunity to dive a bit into the intricacies of Portfolio Management, which is the most important part of financial planning, other parts being expenses planning (which is a very individual specific) and tax planning. 

A holistic Portfolio Management should start with asking certain questions in the following sequence  

     1. Why Portfolio Management?

     2. When and how much to start with?

     3. What instruments are available?

     4. How to implement it and what tools and inputs are required?

As far as WHY part is concerned, I have covered it in my last article. WHEN is something that only you can decide – I will suggest to start ASAP- and HOW MUCH is a function of primarily two parameters, one is your income and other is your recurring or unavoidable expenses. Difference of two should be your saving, but for most of us harder part is deciding and limiting the extent of expenses. My favourite solution for the same is the one suggested by Warren Buffet – save first and spend later, not the other way round. As I mentioned in my last article as well, I had debit authorisation for 1/3^rd of my salary  in place for investments before my first salary came, so I was left with only 2/3^rd of my salary to spend and hence more savings.

I will be majorly covering the HOW part in this article. WHAT part I will be covering in our next article.

HOW part is a step by step process covering following steps –

     1.Profile Determination – It is basically deciding what kind of investor you are, whether you are conservative, aggressive, risk averse, moderate etc. Following parameters decide your appetite as an investor –

1. Age – A younger investor can afford to be invested in longer horizon and comparatively riskier products.
2. Income and Expenses – As discussed, to decide the level of savings that you can afford.
3. Investment Horizon – Generally riskier products are suitable for investors having longer investment horizon.
4. Risk Appetite – It is a very subjective parameter which takes into account EQ and general risk taking ability of an individual.
5. Contingency Related Expenses– Somebody having adequate medical cover and life cover is definitely on a stronger ground than somebody lacking in the same, as he can afford to lock in substantial part in investments without having to think about contingencies which come unannounced.

I will be sharing a tool shortly which will help you in deciding your Profile.

      2.Asset Allocation – Based on Profiling, asset allocation is decided, where relative percentage of fund allocation to different asset classes is decided. Asset classes consist of majorly Aggressive, Moderate and Secured groups (More on Asset classes in next article)

      3. Instrument Allocation – Asset Allocation is followed by deciding the quantum of different investment instruments as per Asset Allocation and Investor suitability e.g. if my asset allocation dictates that I should have 30% of my corpus in Secured Assets, I need to decide how much I should allocate to different Secured instruments like FDs, Debt Funds, PPF etc. Instrument Allocation must be followed by two guiding principles –

1. No Under-diversification – Money should be distributed among a number of instruments so that Risk imbibed in different instruments is squared off. To take an example, typical wisdom says that Debt funds perform in opposite direction to Equities. Hence your portfolio should have adequate exposure to both , though relative quantum may differ based on market conditions
2.  No Over-Diversification – Earlier principle sometimes lead to investors taking exposure to too many instruments , which may prove to be counter-productive as we all know “too many cooks , spoil the meal “.  

Instrument Allocation takes following inputs into account –

1. Time Bucketing – time for which different instruments should be invested
2.  Liquidity – whether an instrument is available for withdrawal anytime or has certain restrictions.
3. Tax Implication – In a country where most of the savings are taxed at a rate as high as 33%, tax implications of the savings instruments proves to be a very critical input in decision making of asset allocation e.g while an FD may sound better than a Debt Fund as it has assured returns, situation changes once you take into account Tax implication of both.
4.  Financial Goals – All of us have some financial goals in life like MBA after 2 years, marriage after 5 years, children education etc. A good instrument allocation should take all such goals into account. Instrument allocation should be in sync with Financial Goal’s deadline and quantum.
5.  Expected and Historical Returns – while past performance of instruments can never be a robust parameter of judging a fund’s suitability, they definitely provide a good tool to analyse a fund’s relevance to one’s expectations from his portfolio. 

     4. Regular Review and Changes – while above lines may give an impression that Portfolio Management is an one shot exercise , reality is it is always an ongoing process which keeps on evolving based on changes in parameters that decided its framework. So one should review his portfolio at regular intervals to ensure that it is aligned to changing needs and market conditions.

I have been personally following the above framework for last 7 years and have found it to be an evergreen and robust approach which has stood by the various financial cycles (2008 downturn to cite one). Though everybody has his own approach and attitude towards money , I sincerely hope that my experience and learning do help you in managing your money in a more efficient and effective manner.

Keep sharing brickbats and feedback J