Types of Portfolio Strategies: One of the lessons financial markets have taught us recently is that the only guarantee is ‘change’. Over the years, economists and investors have to come up with various theories to accurately predict how the markets move.
However, none of them have been a hundred percent accurate. It is because markets are driven by emotions and there are no measures to quantify them in number.
In volatile markets, having some strategies to manage your portfolio is a must. In this article, we will have a look at the different types of portfolio strategies. Keep reading to find out!
What is a Portfolio?
A portfolio is a collection of financial instruments such as shares, stocks, bonds, mutual funds, commodities, exchange-traded funds (ETFs), and even cash.
Apart from the traditional instruments assets such as real estate, art, and private investments can form part of the portfolio.
Why is it Important to Have Strategies?
A strategy is a roadmap by which the investors can use their assets to achieve their financial goals. The financial markets are unpredictable.
It is because the markets are driven by human emotions. In addition to that, any unfavorable event can lead the markets to move drastically.
Types of Portfolio Strategies
Therefore, as an investor, you should not get swayed by any sudden upside or downside. Having a clear objective in mind is important.
Preserving your capital as an investor should be the primary goal. Making a profit using that comes later. To do so, it is essential to have good strategies to hedge the risk.
Types of Portfolio Strategies
Here are some of the common portfolio strategies used by investors and traders around the world:
Portfolio Strategies #1 – Active Portfolio Strategy
An investor going with an active strategy is looking to beat the benchmark returns. It is an investment approach in which investors use a variety of forecasting and assumption techniques to determine which securities to purchase in order to gain higher returns.
An investor following this strategy has to be more active in the markets and make trades frequently.
An investor using the active portfolio strategy has a long-term aim of moving capital on a consistent basis into profitable securities.
Apart from that, that investor is trying to identify stocks that are mispriced or undervalued in the current markets. This strategy is suitable for risk-takers.
Portfolio Strategies #2 – Passive Portfolio Strategy
The passive strategy is the opposite of the active strategy. It is a more hands-off approach. This strategy tracks the market-weighted index.
Passive portfolio strategy is also known as ‘passive investing’, ‘passive strategy’, and ‘index investing’.
The underlying principle behind this theory is that the markets are efficient. Also, the investors following this approach tend to believe that it is impossible to beat the markets.
It is also a good way to minimize the cost of handling a portfolio as professionals charge fees to do so.
Portfolio Strategies #3 – Aggressive Portfolio Strategy
The aggressive portfolio strategy is used by risk-takers. As the name suggests, this investment style aims at maximizing returns by taking a relatively higher degree of risk.
An investor prefers to invest in expensive stocks that provide good returns
Capital appreciation is the primary objective rather than preserving capital. The ideology behind this type of investing is ‘Big rewards carry big risk’.
The stocks chosen are of companies that have shown rapid growth and are expected to generate rapid earnings over the next few years.
Portfolio Strategies #4 – Defensive Portfolio Strategy
This type of portfolio strategy involves the collection of stocks after carefully observing the trends such as market returns, earnings growth, and dividend history.
Generally, these investors are conservative about their investments and the type of strategy that they are willing to use to manage their portfolio.
The risk-averse investors regularly rebalance their portfolios to maintain an intended asset allocation. This strategy focuses on delivering protection first and then focusing on growth.
The investors using this strategy looks for stability and consistency. Apart from the strategies discussed above, here are some more strategies or techniques used for managing portfolios.
Portfolio Strategies #5 – Diversification as a Strategy
Adding a wide range of securities to your portfolio is termed diversification. In an attempt to limit exposure to the fluctuations in any single asset, it is advised to have a mix of distinct investment vehicles that can help achieve higher returns with lower risk.
Diversification is a key component of the Modern Portfolio Theory (MPT). As per the theory coined by Harry Markowitz, investors could achieve their best results by choosing an optimal mix of high risk and high return or low risk and low return asset classes.
According to the experts, over-diversification is when you have over 20 stocks in the portfolio. On the other hand, under-diversification is when the mix has less than 3 stocks. The ideal mix should be 8-20 stocks.
Portfolio Strategies #6 – Non-Correlating Assets as a Strategy
The risk in the market is classified into two categories. The first is a systematic risk that is always present and cannot be controlled by either the company or investors.
Unsystematic risk on the other hand can be reduced by taking certain actions. Having non-correlating assets is one such measure.
Non-correlating assets, in simple terms, mean that two different assets react differently to market changes. Generally, they move in the opposite direction showing an inverse relationship.
This helps to even out the volatility in the overall portfolio.
An example can be the Russia-Ukraine war and its effects on two non-correlating assets Gold and Stocks. The news sparked the biggest crash of the Indian stock markets in the last few years.
The benchmark indices SENSEX and NIFTY50 tanked by 4.72% & 4.78% respectively leaving all its constituents in red.
On the other hand, commodities like gold spiked up by ₹2,250 to ₹52,630 per 10 gram while silver jumped 5% to ₹67,926. It is because these commodities are considered safe haven for investors.
Portfolio Strategies #7 – Stop Loss order as a Strategy
The stock prices will move up or down depending upon the demand and supply of the stock. The price discovery happens when the bid price (by the buyer) and ask price (by the seller) meet at an equilibrium. Thus, the stock price moves every millisecond.
As an investor, the change of a single rupee can lead to significant gains or losses. Therefore, investors must take extra caution while buying and selling securities and make sure they get the best price possible.
One such way is to place a stop-loss order. It is a tool used by traders and investors to limit losses and reduce risk exposure.
With stop-loss, an investor is able to exit an investment if the price moves to a certain level. These orders are automatically executed once the set price is reached.
Portfolio Strategies #8 – Dividends as a Strategy
Investing in stocks can generate two types of returns for the investors. The first is capital appreciation. It is when the stock price increases or moves up. The second way to earn from stock is through dividends.
When a company earns profits or a surplus, it pays a portion of them to the shareholders. These parts of profits are known as dividends.
Investing in stable companies that pay dividends is a proven method for delivering above-average returns.
Analyzing certain metrics can be a prudent way to find the best dividend-paying stocks. For example, dividend yield shows how much the company pays out in dividends each year relative to its stock price.
The other popular metric to evaluate the dividend of a company is the Dividend payout ratio which shows what portion of the net income is being paid out as dividends. These types of portfolio strategies are adopted by people who want to generate another source of income.