There are four main types of portfolio management. Each one has certain advantages and disadvantages that investors should carefully weigh before making a decision.
Active Portfolio Management
An active portfolio management style is led by a fund manager or team of investment analysts and fund managers who actively watch the markets, analyze securities, and make predictions about market direction. Selection of assets is based on ratio analysis and other investment methodologies. The portfolio manager is often a critical element as well since they make the final decisions on what to buy or sell. Because of this, active management styles may underperform or outperform the broader market averages.
This type of management attempts to beat the market averages, which means that active management often has higher risk as investment decisions may not always be accurate or result in as profitable a position as expected. Active management means having larger fees associated with it as well, since it requires constant market vigilance by the portfolio manager to choose securities based on their trading criteria.
Active management is ideal for investors that desire more diversification for their investment portfolio and have a good appetite for risk as well. Having a professional invest on one’s behalf is also beneficial for investors who may not have the time to dedicate to managing their own portfolios.
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Passive Portfolio Management
The most recognized form of passive management is an index fund. Instead of attempting to time markets or select specific securities to build a portfolio, a passive style attempts to mimic the benchmark index it is tied to. For example, the Vanguard S&P 500 Index Fund (VFINX) invests in a basket of stocks that will track along the S&P 500’s performance.
Passive portfolio management means having lower expenses since no one needs to select securities, determine asset allocation levels, rebalance holdings, or hedge against future risks. Under certain scenarios, passive portfolios can beat actively managed portfolios. However, it must be noted that since the portfolio only seeks to track an index, it doesn’t hedge against downside risk, resulting in large swings that investors should be prepared to see.
Passive portfolio management is best for investors who are willing to have their investments subjected to the whims of market movements. Passive investment can be more volatile than actively managed portfolios.
Discretionary Portfolio Management
In discretionary management, the portfolio manager makes all the investment decisions without any input from the investor. Mutual funds, hedge funds, and other similar investment vehicles use a discretionary management style to invest.
For investors who don’t have time to dedicate to investing or don’t have the knowledge base required to be a successful investor, having professional management make investment decisions on one’s behalf can be beneficial.
However, reliance on someone else to make the right choice when choosing investments means that your investments may not precisely match your risk tolerances. The manager may invest more conservatively or more aggressively than you would like.
Non-Discretionary Portfolio Management
In contrast to discretionary management, a non-discretionary style is when the investor makes all the investment decisions while the manager takes on more of a consulting role. Most financial advisors fall into this category by presenting investors with options, discussing the merits of each, but ultimately letting the individual investor select which assets or securities they want to invest in.
The advantage of this style is the freedom given to the investor to make choices and guide the portfolio while still having a professional management to rely on for expert advice and opinions. For investors who have the time to dedicate to monitoring their investment accounts, or have some knowledge of the markets and investments already, this type of management may be preferable.
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