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Manage and Evaluate Your Portfolio Return

Portfolio management is the process of developing and maintaining your financial assets as a means of achieving your financial goals. Performance evaluation is the process of analyzing your portfolio’s return performance with the goal of identifying your key sources of return. These two processes are somewhat complicated, but both are critical to successful investing.

Portfolio Management Styles


Active portfolio management: In active portfolio management, investors use publicly available data to make decisions about actively buying and selling financial assets. The goal of this investment strategy is to beat the benchmarks after all transaction costs, taxes, management fees, and other expenses have been accounted for. This strategy can be considered successful only if it works consistently year after year—not if the strategy works for one lucky trade. Active management is expensive: management fees for actively managed mutual funds that consistently outperform benchmarks are five to twenty-five times higher than the management fees for passively managed mutual funds (18 basis points for an index fund versus 250 basis points for an actively managed fund).

Passive portfolio management: In passive portfolio management, you buy a well-diversified portfolio of financial assets (usually a broad market index) and you do not attempt to outperform the market by buying under-priced securities or selling over-priced securities. Most actively managed funds fail to outperform their benchmarks, especially after transaction costs and taxes have been accounted for. Investors have realized that the saying “if you can’t beat them, join them,” applies well to investing, and so they buy low-cost, passively managed index funds, which consistently match their benchmarks and minimize ta



Factors that Lead to Above-Benchmark Returns

Two main factors lead to above-benchmark returns: superior asset allocation and superior stock selection.

Superior asset allocation: Superior asset allocation requires you to be sensitive to changes in the market and adjust your portfolio’s asset allocations accordingly: you must change allocations from poorly performing asset classes to high-performing asset classes to receive above-benchmark returns. You must shift your portfolio’s allocations among stocks, money market funds, bonds, and other asset classes based on your expectations for return from each of these asset classes. Having superior asset allocations yields higher returns with lower risk. If assets are not allocated well, the result is lower returns, higher transaction costs, and higher taxes.

Superior stock selection: Superior stock selection requires you to pick sectors, industries, or companies that correspond with a specified benchmark and together outperform the specified benchmark. To build an investment portfolio that earns returns in excess of the benchmark, you must carefully buy or sell undervalued stocks while working to purchase securities in an index that contains stocks with the highest growth potential. Superior stock selection yields higher returns with lower risk. Poor stock selection yields lower returns, higher transaction costs, and higher taxes.


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