Many self-directed investors feel challenged when looking to implement sound investment portfolio management.
Yet, it can’t be stressed enough that failing to show your portfolio some love and attention is likely to generate a tremendous drag on your investment returns over time. Adding insult to injury, your portfolio risk can quickly surpass your tolerance levels. And, you may be missing out on opportunities.
Granted, it can be cumbersome to look after one or several portfolios with dozens of positions. Fortunately, today’s private investors have a great deal of tools and data at their disposal to implement a sound portfolio management strategy. They can rely on various platforms designed specifically for them to assist them with portfolio management, dividend tracking and investment research. By making use of these apps, they can confidently manage their investment portfolios and reach their long-term investment goals.
Get Ziggma’s suite of portfolio management tools to own your best portfolio.
In this post, we explain how to implement a sound approach to investment portfolio management, by addressing the following points.
✅ What are the key parameters to watch?
✅ How to monitor your key portfolio metrics?
✅ How to make adjustments and optimize your portfolio?
✅ How Ziggma can help you better manage your portfolio?
Meeting market dynamics with sound investment portfolio management
Portfolios are dynamic – even if you don’t trade. Imagine you constructed a five-stock buy-and-hold portfolio, equally weighted between five stocks TSLA 📈, JPM 📈, AAPL 📈, DIS 📈 and ACN 📈. During TSLA’s heyday, your portfolio would have become completely unbalanced and the principle of diversification would have gone out the window.
In the specific case of Tesla, the risk from poor diversification was amplified. Despite its huge gains in the stock market, TSLA was not exactly the financially soundest company at the time. The company was hugely loss-making and massively dependent on carbon credits – without which its losses would have been even bigger. It was highly indebted and dependent on a single factory. A bit of a house of cards really. So this hypothetical portfolio would have ended up exposed at 50-60% to a company that was not far from going bust at the end of the day.
1. Start with proper portfolio diversification
You have heard it so many times: the famous “eggs and basket” analogy telling you not to put all your eggs into the same basket. A well-diversified portfolio will provide you with a significant degree of downside protection. We are not saying that you can’t have a couple of high-conviction positions. But make sure to mitigate portfolio risk by not letting a single stock take over the entire portfolio, as shown in the previous example.
Risks affecting an investment portfolio
As we explain in our blog article “The Importance of Investment Portfolio Diversification and How to Monitor It“, proper portfolio diversification addresses two types of risks: Idiosyncratic risks, i.e. risk specific to a company or an industry, and market risks.
Idiosyncratic Risk
Any company is exposed to a multitude of risks. These can come from the inside, for example from bad management, or from the outside, such as regulatory changes or natural catastrophes. Similarly, at the industry level, entire industries face risks as well, for example, structural change.
Market Risk
Expressed as market volatility, market risk affects all market participants and assets. Drivers are factors such as political conflict, inflation, or interest rates. These factors will affect different types of asset classes, industries and even companies in different ways.
How to construct a well-diversified investment portfolio?
When it comes to investing styles and risk tolerance, the right formula differs from one investor to another. These circumstances may even change over an individual investor’s lifetime. If you are a risk-averse investor, your diversification strategy needs to start at the asset level. You will need to build your portfolio on bonds, large diversified ETFs, and perhaps large-cap stocks. If you are young and prepared to take on some risk, you are likely to invest in stocks of high-growth companies.
Main diversification categories
While there are a range of categories by which you can diversify your portfolio, the most important diversification categories are asset class, geography, sector, industry, marketcap and growth vs. value.
Geography
Nowadays, global brokers, such as Interactive Brokers or Webull, make it possible to implement geographic diversification to a portfolio. This means that you can own stocks from outside your country or even continent at a very reasonable price, thereby adding geographic diversification to your portfolio. There are also many ETFs that focus on particular countries or regions.
Asset class
As mentioned in the introduction, different asset classes come with their respective distinct risk and return profiles. These must be taken into account against the backdrop of your individual financial situation and degree of expertise. The main asset classes to consider are bonds, stocks, ETFs, and increasingly alternative asset classes, such as cryptocurrencies, peer-to-peer lending, and crowdfunding, or even collectibles. If you think bonds are too complex, you can easily get exposure to this asset class via bond ETFs.
Industry
The Ziggma screener comprises 31 different industries. So there’s plenty of diversification to be had. You can own tech stocks, utilities, energy stocks, business services, banks and more. Even industries themselves can be very heterogeneous. As part of a sound investment portfolio management, you want to nmake sure that you spread your holdings across different industries.
Market capitalization
Diversifying by market capitalization involves investing in companies of varying sizes, categorized into large-cap, mid-cap, and small-cap stocks. This strategy helps spread risk across different market segments, as each category tends to perform differently under varying economic conditions. The benefits of this approach include reduced volatility in the investment portfolio, as gains in one segment can offset losses in another, and exposure to growth potential, particularly from small- and mid-cap companies that may offer higher returns. Additionally, it allows investors to capitalize on the stability of large-cap companies while still seeking the growth opportunities that smaller companies may provide.
How to monitor your portfolio diversification
To monitor portfolio diversification, start by reviewing the percentage of your investments across different asset classes, such as stocks, bonds, and cash. Check for over-concentration to maintain the desired level of diversification as market conditions change.
A common rule of thumb for avoiding overconcentration is to ensure that no single asset or sector represents more than 10-15% of your total portfolio. Additionally, maintaining exposure across at least 5-7 different sectors or asset classes can help reduce risk. This balance allows for diversification while preventing one investment from significantly impacting overall portfolio performance. Regularly reviewing and adjusting your holdings as market conditions change is key to maintaining this balance.
Need a more generic rule for a large or small portfolio? Consider setting your limit by following the formula (1/total number of stocks) + 10%.
Useful tools
Once a portfolio is set up, busy schedules and lives often take over leading to unintended concentrations and subsequent increases in risk profiles.
Ziggma’s Smart Alert alleviates this problem. They are as easy to set as they are effective. Using a sliding scale, the user sets a tolerance limit for exposure to a single stock or holding. As soon as the threshold is hit, the user is notified so that (s)he can take measures to keep their portfolio balanced.
2. Risk Management
Keeping a portfolio diversified is already a form of risk management and thus represents an integral part of a sound approach to investment portfolio management. But there is more to risk management. Unfortunately, many investors flinch when they hear the term risk management, which they tend to associate with complex math. But that’s a fallacy. Proper risk management is accessible to anyone. Paying close attention to the following two risk parameters can make all the difference.
Monitoring portfolio beta as an integral part of investment portfolio management
Knowing your portfolio’s beta gives you an indication of how much fluctuation to expect from your portfolio relative to the overall stock market (the S&P500 to be precise).
It’s simple and there’s no need to overcomplicate matters. If your portfolio beta is equal to 1, you can expect your portfolio value to fluctuate in tune with the broader market. If your portfolio beta is significantly greater than 1, you may have to hold your breath at times, as the swing in your portfolio value will see higher fluctuations (often referred to as volatility) than the broader market. Vice versa, if your portfolio’s beta is below 1, you will see less volatility than the S&P500.
Outperformance with a low-volatility portfolio
Did you know that low-volatility stocks tend to generate higher returns than high-volatility stocks? In case you didn’t, then you may want to learn about the low-volatility anomaly.
In essence, by showing that those low-volatility stocks have higher returns than high-volatility stocks in most markets, the Capital Asset Pricing Model (CAPM) is essentially invalidated. This widely followed theory stipulates that a stock’s expected return should be a positive and linear function of beta. Various empirical studies show however that by owning a low beta portfolio you increase your chances to outperform the market.
As we explain in our post “Why are you can beat the market with low beta stocks“, our Low Beta Stocks model portfolio outperformed the market by 11% year to date, at the time the post was written.
Sharpe Ratio
The Sharpe Ratio is a widely followed measure that puts investment return in perspective by measuring it against the risk taken on to achieve the returns. The concept is very simple. For example, for an identical rate of return of 10% per annum, it is preferable to achieve this with a lower rate of volatility. It provides for better sleep and a lower drawdown at any given point in time. The Sharpe Ratio for a 10% return with a lower degree of volatility would be higher than for the same rate of return that is achieved at a higher degree of volatility. Investors generally aim to achieve a Sharpe Ratio that is higher than 1.
3. Portfolio quality – An integral part of investment portfolio management
Often overlooked, portfolio quality and evolution over time is a key success factor for investing success. By consistently staying on top of portfolio quality, investors can both identify underperforming assets and proceed to make timely adjustments. A robust approach to tracking portfolio quality lets investors reach or even surpass their return objectives while minimizing unnecessary losses.
One way to approach this is by keeping an eye on your portfolio dashboard. It will show key parameters, such as portfolio performance, portfolio risk, overall portfolio quality and portfolio yield. Naturally, you want these parameters to improve for your investment portfolio over time. The best portfolio trackers will help you monitor the evolution of these parameters over time – an insight that is extremely powerful towards reaching your target return.
Monitoring portfolio companies’ financial performance
Just like professional investors, you will want to track how your portfolio companies’ business KPI evolve compared to when you first bought stocks in them. You can do this by writing down its profitability level, growth rate or financial situation at the time of the purchase in a spreadsheet.
Some of the best portfolio trackers will actually provide you with a feature to help you track your portfolio companies’ KPI through time against their value when you first bought the stock.
Ziggma’s company KPI tracking feature was designed to help you keep tabs on your portfolio companies’ financial performance. It connects companies’ current level for a specific KPI with its level at the time a stock was bought.
Specifically, Ziggma users can consult portfolio companies’ key metrics, such as price-to-earnings ratio, return-on-equity, net margin, revenue growth or income growth in a single tab. Current values are respectively compared to the level at the time of purchase. This makes it extremely easy to visualize whether a company is making progress or not. In the event that a company’s performance is deteriorating, divestment may become necessary before things get worse.
Professional portfolio managers spend many hours monitoring their portfolio companies’ financial progress over time on growth, profitability, or balance sheet strength.
Socially and environmentally responsible investment equals higher returns
Knowing how exposed and how well your portfolio companies manage their material ESG issues has become an increasingly important part of making well-informed investment decisions. There’s a growing body of industry research that supports the proposition that there are positive correlations between ESG rankings and risk-adjusted equity returns. In light of the short track record of ESG scores, as well as their ongoing shortcomings, this statement needs to be taken with a grain of salt.
Yet, there is a high probability that the proposition is true. In the end, what an ESG score ultimately reflects is how well a company is managed. The E, which stands for environmental, addresses preparedness for the many all too familiar environmental challenges, including climate change. The S, which stands for social, captures a company’s concern with social issues. This is not only important in itself but it can also protect companies’ reputations from backlashes through social media against the backdrop of shortcomings on social issues. The G, which stands for the government(al), reflects a company’s performance on corporate governance. This can range from shareholder involvement all the way to employee pay. It is apparent that the range of topics that go into ESG scores is vast. But so is the scope of responsibilities for a senior management team in literally any company.
Investment portfolios are dynamic. We believe that the concept of buying and hold in the strictest sense is a fallacy. Just think about this. Some portfolio companies will always fall behind their peers just as your favorite sports team will not win the championship each year. Or, as in our example on portfolio diversification, following strong performance some stocks will at some point make up a disproportionate share of your portfolio. So, far from becoming a day trader, you will want to act once a portfolio company is no longer best-in-class within its industry. Just like you would want to take action when a portfolio holding starts to make up a disproportionate share of your portfolio.
A robust approach to investment portfolio management: The key to your success
The importance of a sound approach to investment portfolio management cannot be overstated. Michael Burry, famous through „The Big Short“, recognizes the importance of good portfolio management as early as in the second sentence of his famous one page investing memo when he writes: “Management of my portfolio as a whole is just as important to me as stock picking.”
Way too often, portfolio management takes second place to stock research among private investors, leading to poor returns. Being aware of the necessity of a sound approach to investment portfolio management in our capacity as both professional and private investors, we set out to build Ziggma to provide the self-directed investor with a proper set of tools to succeed on their investing journey.