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Portfolio management

Portfolio Management

What is Portfolio Management?

Justin Kuepper Mar 28, 2019


There are literally thousands of different securities available to investors, including stocks, bonds, funds, commodities, real estate, and other niche assets. The process of matching combinations of these investments to an investor’s investment objectives and constraints is known as portfolio management.


In this article, we will take a closer look at the process of portfolio management and how dividends play a role.


The Portfolio Management Process


Portfolio management is a complex process that’s usually done by a financial professional on behalf of an individual client. Often times, individuals use a financial advisor to make investment decisions and build a portfolio on their behalf in exchange for a fee or commission.

Let’s take a look at the three core components of portfolio management.

Plan

The planning phase begins by identifying investment objectives, or desired performance outcomes, as well as any constraints or limitations. The two most important factors to address when developing investment objectives are risk and return, while constraints include both internal and external factors.

The next step is writing an Investment Policy Statement (IPS) that governs all investment decisions for the client. In particular, the document should incorporate the objectives and limitations with a focus on the client’s needs, preferences, and circumstances that could impact decision-making.

The final step of the planning process is establishing strategic asset allocations. Portfolio managers must balance long-run investment performance expectations with the client’s objectives and constraints to find the right mix of investments to generate sufficient returns at an acceptable risk.

Execute

The execution phase involves identifying specific portfolio investments. In most cases, portfolio optimization is incorporated to efficiently combine assets to meet risk-and-return objectives.

Use the Dividend Screener to find high-quality dividend stocks. You can even screen stocks with DARS ratings above a certain threshold to find the right investments for your portfolio. You can also see our updated list of the best dividend stocks here.

Adjust

The adjustment phase involves evaluating the performance of the portfolio on a regular basis. Often times, performance is assessed by looking at how well the portfolio manager performed on a risk-adjusted basis relative to a benchmark portfolio, such as the S&P 500 index.

In addition to evaluating performance, portfolio managers must monitor and rebalance the portfolio to continue adhering to the client’s investment objectives over time. Rebalancing may be necessary due to investment performance or the client’s changing requirements over time.


How Dividends Impact Portfolios


Dividends play an important role in portfolio management. In fact, more than 80 percent of the total return of the S&P 500 index between 1960 and 2017 can be attributed to reinvesting dividends! As a result, Dividend Reinvestment Plans, or DRIPs, have become popular among blue-chip stocks.

Hartford Funds found that companies that grew or initiated a dividend experienced the highest returns relative to other stocks between 1972 and 2017 with significantly less volatility. The combination of greater stability and higher returns makes dividends compelling for portfolio managers.

Dividends are also appealing to retirement investors who rely on fixed income from their portfolio.

Qualified dividends also have favorable tax treatment compared to other forms of income. If a stock is held for more than 60 days, these qualified dividends are taxed at the capital gains tax rate rather than the ordinary tax rate, providing a potentially tax-efficient income stream.

By comparison, preferred stock holding periods should be significantly longer to achieve the same tax treatment. Bond income is also often subject to ordinary income tax with the exception of municipal bonds that may be exempt from certain state or federal taxes.

Don’t forget to check out this article to know whether dividends can hedge you against inflation.


Adding Dividends to a Portfolio


The most common strategy for incorporating dividends into a well-rounded portfolio is through dividend-focused index funds or exchange-traded funds (ETFs). These funds hold a diverse portfolio of dividend-paying stocks that meet minimum criteria, which simplifies the process of actively managing a portfolio as well as reducing the cost.

When choosing a dividend-focused fund, it’s important to be cognizant of the expense ratio and any other fees. These costs are necessary to cover the expense of managing the portfolio, but they should be minimized to maximize the client’s risk-adjusted returns over time.

There are also many different flavors of dividend-focused funds to consider, such as:

  • High Dividend Funds: These funds focus on high dividend yields – often greater than five percent.
  • Dividend Aristocrats: These funds focus on high-quality companies that also offer dividends.
  • Dividend Growth: These funds focus on companies that have consistently increased dividends over time.

Click here to learn more about the dividend-growth investment strategy.


The Bottom Line


Portfolio management is the process of identifying a client’s investment objectives, building a portfolio that meets those objectives, and keeping that portfolio up-to-date over time.

Dividends play an important role in portfolio management given their superior performance, lower risk, and potential for tax-efficient income. While past performance doesn’t guarantee future results, these attributes certainly merit a second look for financial advisors and other portfolio managers.

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