Portfolio management is the process involved in decision-making and management of processes in an organization used by managers (Fabozzi & Markowitz, 2013). Portfolio management can also be described as the process where managers of an organization make investment and policy decisions where investments and policies are matched and directed to an organization’s goals and objectives (Fabozzi ; Markowitz, 2013). The managers are also involved in the distribution and allocation of assets for the organization as well as the staff members, which is an important risk management process. Portfolio management ensures a balance between an organization’s risks and its performance. This balance can be acquired by the analysis of an organization’s strengths, weaknesses, opportunities, and threats (Fabozzi ; Markowitz, 2013).
The Relationship between Risk and Rate of Return
Risk and the rate of return closely interrelate with each other as they are directly connected to each other (Fabozzi ; Markowitz, 2013). When the risk level is low, the rate of return is also low and its increase will result to high returns. Different investment options result in different rates of return. High-risk investments can result in high profits as well as high losses (Fabozzi ; Markowitz, 2013). The amount of return on any investment is determined by the risk level and a high return implies a high risk taken. For an investor to guarantee high profits, they must also be ready to accept the possibility of losses (Fabozzi ; Markowitz, 2013). The rate of return will attract an investor in choosing between different investments options in the market. The risk factors are also considered and their impact on the returns in any investment (Fabozzi ; Markowitz, 2013).
Portfolio That Will Minimize Risk and Maximize Rate of Return
A portfolio is the selection and grouping of an organization’s financial resources and other securities, which may include stocks, treasury bonds, and other cash equivalents, integrated into different investments in an organization (Rajagopal, 2013). Diversifying a portfolio will help an organization in minimizing risk and maximizing the rate of return. Diversification involves an organization choosing investments that have the potential to change in their value at different times (Rajagopal, 2013). This can result in differences in the risks involved in different times enabling an organization to manage the risks better which will positively impact the returns.
When investments have an increased value, the organizations can take advantage of this time and reap the benefits associated with this value. Diversification can also benefit organizations when one investment fails or loses its value, as this will have a minimal effect on the overall returns of the organization (Rajagopal, 2013). Diversification provides security for any organization and can help an organization in managing the risks associated with certain types of investments. Even if some investments lose their value, the organization has other investments that it can rely on and still provide returns for the organization (Rajagopal, 2013). The loss of value of any investment results in no risk to the organization as diversification reduces the chances and impact of risks as the risks have been spread over the investments (Rajagopal, 2013).
Through diversification, the impact that losses may have is minimized in the portfolio, as may be the case with a single investment (Fabozzi & Markowitz, 2013). A single investment does not have an option plan or salvage plan and losses negatively impact an organization (Fabozzi & Markowitz, 2013). A single investment is only beneficial for a guaranteed positive outcome of an investment, which is rare in most cases, as investments cannot be accurately predicted, and outcomes may differ between different organizations and different factors may affect the outcomes (Fabozzi & Markowitz, 2013). Organizations can achieve this by not investing all their resources or their best assets into one investment as this can have a negative effect if unexpected outcomes arise (Fabozzi & Markowitz, 2013).
Diversification is also beneficial to an organization that has no confidence or is unsure about certain investments. Diversification is one of the most effective portfolios that can guarantee minimized risks and increased returns (Rajagopal, 2013). Diversification’s main purpose is to reduce the risks associated with certain investments by distributing the risks in the available investment options. Since risks have a direct relation to returns, minimized risks will result in increased returns. For an organization to reap the full benefits of diversification, it can diversify its resources on the investments that provide the highest returns (Rajagopal, 2013).
Formulate an Argument for Investment Diversification in an Investor Portfolio
Investment diversification is important especially in long-term investment options (Hu?nseler, 2013). Investment diversification can help in predicting future outcomes and provide consistent outcomes, which are beneficial in planning and strategy implementation (Hu?nseler, 2013). Portfolio diversification also minimizes investment risks associated with certain types of investments and can help organizations in reviewing their performance and returns implementing better strategies, which will positively impact their returns and minimize their risks more (Hu?nseler, 2013). An organization can offset or close an investment that may have a negative outcome affecting the overall portfolio.
There are negative effects associated with investing in a single investment as an increase in the risk levels also increases the probability of losses but through diversification of spreading an organization’s resources in a market, this risk is reduced and can guarantee more growth and more value for the organization (Hu?nseler, 2013). Portfolio diversification helps in managing portfolio losses and helps in maintaining a certain market share. Although portfolio diversification may not guarantee a high return, it is important in the end in minimizing risks and guarantees a certain rate of return (Hu?nseler, 2013). Portfolio diversification also allows evaluation and a rebalancing of the investment mix for better performance and total outcome. By organizations using portfolio diversification, total risks can be reduced and since risks have a direct relation with returns, minimized risks will lead to stable returns (Hu?nseler, 2013).
Address How Stocks, Bonds, Real Estate, Metals, And Global Funds May Be Used In A Diversified Portfolio. Provide Evidence In Support Of Your Argument
A portfolio includes an organization’s monetary resources, which have certain disadvantages. Having diversified monetary resources will lessen the negative effect associated with each resource. A broadened portfolio will enable spreading of associated risks and guarantee a better performance (Kevin, 2015). Stocks, bonds, real estate, metals, and global funds can be used as part of these monetary resources as each one of these has a risk involved in its use. However, utilizing these resources collaboratively will help an organization reap the benefits of certain resources while minimizing the risks that may occur with other resources (Kevin, 2015). Using these resources altogether protects the investor from the negative effects in a specific market.
Stocks have high risks involved with high gains as well as high losses for investors (Kevin, 2015). Because of this high probability of gains, investors can invest in stocks but because of the possibility of losses, the investors can diversify their investment to other markets. Investing in the stock market has a benefit to the investor as this gives him/her ownership rights in the company, which acts as a form of security for the investor (Kevin, 2015). Stocks can help investors in managing the losses incurred on other investment options. However, due to the huge gains associated with stocks, an investor cannot ignore this investment option (Kevin, 2015).
Bonds are better to invest in than stocks since its loss is minimal compared to stocks (Romano, 2017). Bonds have a high liquidity rate than stocks and have a steady and a stable return. For these reason, it is important for investors to invest in bonds in their portfolio diversification (Romano, 2017). Investment in bonds is safer and is not influenced by the market as stocks are. Bonds are also secure and investors are legally protected (Romano, 2017). This lowers the risks associated with bonds, which increases the future predictions of a steady return. Due to their simple use and access, investors using the portfolio diversification can benefit from investing in bonds if other investments have negative returns. Although bonds have a limited rate of return, they are consistent and have a guarantee of a certain return, which is important in every investment (Romano, 2017).
Real estate investment can increase the return of a large portfolio and is important in reducing the associated risks associated with a certain portfolio. Real estate ensures a maintained and constant return for a given portfolio (Romano, 2017). Portfolio diversification into real estate will guarantee investors with a steady return with reduced risks. Real estate investment has an advantage to the investor, as one is able to increase its value unlike stocks and bonds. An investor is able to increase the value in real estate by improving the amenities associated with a real estate, which can include more furnish and environment improvement (Romano, 2017). With the minimal risks associated with real estate, investors can include real estate investment with other investments in portfolio diversification, which will guarantee return if other investments fail to bring returns to the organization (Romano, 2017).
Diversifying a portfolio with precious metals can enable an investor to manage the negative performance of other investments. Precious metals include gold, precious coins and platinum (Pandya, 2013). These metals are tangible resources and important in ensuring the security of an investor. Investment in precious metals is important especially in long-term investment. These metals can be traded at any time making them one of the investment assets that can be easily liquidated compared to other investments (Pandya, 2013). Precious metals are not affected by economic factors, which may include inflation like other investments, which is a basis for diversification by investors (Pandya, 2013). Investors want to invest in investments with positive returns and precious metals are a form of security for the investors and guarantee a certain return when liquidated (Pandya, 2013).
Portfolio managers may also invest in global funds, which is investment in different national markets by spreading their investments in these markets (Pandya, 2013). The performance index may be better in countries other than the United States. Investments in markets overseas may guarantee better returns than in the United States. This is based on the current market conditions, exchange rates, inflation, and technology, which may affect the performance of certain investments (Pandya, 2013). This is a strategy aimed at reduced risks associated with certain investments and diversifying a portfolio, which ensures a certain rate of return (Pandya, 2013).
Evaluate the Concept of the Efficient Frontier and How You Will Use It to Determine an Asset Portfolio for a Specified Investor
The concept of the efficient frontier involves a combination of certain portfolios that guaranteed the highest expected return at the lowest possible level of risk (Kevin, 2015). Portfolios below the efficient frontier are considered ineffective, as they do not give the guarantee of a return based on the risk undertaken (Kevin, 2015). The efficient frontier analyzes the different possible portfolios and their possible outcomes and determines the portfolios that guarantee the highest returns at a given risk level and plots the optimal portfolios on a curve based on past security prices in the portfolio (Kevin, 2015). The portfolio that has a perfect balance between the risk and return is the optimal portfolio. The optimal portfolio is not determined by securities with low risk or securities that have the highest possible returns. The optimal portfolio may have some risks involved but has a possibility of a great return (Kevin, 2015).
The efficient frontier can be used to determine an asset portfolio for a specified investor by calculating the expected return which is an average of the investors assets expected returns where the expected return of a specific assets are added together and any variance depended on the risks involved and the relationship between the investor’s assets (Romano, 2017). The portfolio return is high if the assets have positive returns and have a positive variability based on historical data. The expected returns and variance of the individual assets are plotted on the portfolio frontier graph where each plot represents a portfolio based on a weighted combination of an asset. Points above the portfolio frontier indicate portfolios that are effective for investors and can guarantee large returns (Romano, 2017).
Consider The Economic Outlook For The Next Year In Order To Recommend The Ideal Portfolio To Maximize The Rate Of Return For The Short Term And Long Term. Explain the Key Differences between the Short and Long Term
Considering the economic outlook for the next year, there are several challenges for investors in trying to earn high returns while at the same time minimizing the associated risks. Considering the high interest rates and high fees involved in the markets, this will directly have a negative effect on the returns that investors are expecting (Rajagopal, 2013). The ideal portfolio to maximize the rate of return for the short-term and long-term will be to invest in bonds due to the consistent returns and the minimal risks associated with bonds (Rajagopal, 2013). A combination of stock investment and investment in bonds will guarantee a large return with low risk. With the increasing rate of inflation, it can affect the rate of return on stocks and bonds and because of this, an investor can diversify into real estate for long-term investments to manage the risks associated with the economic changes (Rajagopal, 2013).
Short-term investment involves investment meant for a short period and may include high liquid assets and securities (Fabozzi & Markowitz, 2013). These assets are small compared to the organization’s cash equivalent. Some of the short-term investments include government bonds and money markets (Fabozzi ; Markowitz, 2013). Long-term investment on the other hand includes an organization’s investment in stocks, bonds, and real estate, which it aims to hold for a long period of more than one year (Fabozzi & Markowitz, 2013). A long-term investor can commit himself/herself to a more market risk as they believe that even if the market has a low return it will definitely kick back and have high returns as the investor has a long time in the market (Fabozzi & Markowitz, 2013).
Fabozzi, F. J., & Markowitz, H. M. (2013). Equity valuation and portfolio management. Hoboken, N.J: Wiley.
Hu?nseler, M. (2013). Credit portfolio management: A practitioner’s guide to the active management of credit risks. New York, NY: Palgrave Macmillan.
Kevin, S. (2015). Security analysis and portfolio management. Delhi: PHI Learning Private Limited.
Pandya, F. H. (2013). Security analysis and portfolio management. Mumbai: Jaico Publishing House.
Rajagopal, S. (2013). Portfolio management: How to innovate and invest in successful projects. Houndmills, Basingstoke, Hapmshire: Palgrave Macmillan.
Romano, L. (2017). Project portfolio management strategies for effective organizational operations. Hershey, Pennsylvania IGI Global.