What Is Portfolio Management? How It Works

Portfolio management involves picking investments such as stocks, bonds and funds and monitoring those investments over time. It requires a cohesive investing strategy based on your goals, timeline and risk tolerance. Portfolio management can be done with a professional, on your own or through an automated service.

What is a portfolio?

A portfolio is a person’s or institution’s entire collection of financial assets. This can include stocks, bonds, mutual funds, real estate, cryptocurrency, art and other collectibles. A "portfolio" refers to all of your investments — which may not necessarily be housed in one single account.

What does a portfolio manager do?

A portfolio manager creates an investing strategy based on a client’s financial needs and risk tolerance, and provides ongoing portfolio oversight, adjusting holdings when needed. You don't need a portfolio manager if you'd prefer to manage your investments on your own, but if you'd rather be hands-off or want advice and help, you may want to work with a professional.

If you're working with an in-person portfolio manager, there are a few different credentials to look for.

• Anyone managing your money should at the very least be a registered investment advisor.

• Ideally, look for someone who is a certified financial planner. That means they have a very high level of education and a fiduciary duty to you as their client.

Active vs. passive portfolio management

The two main portfolio management strategies are active and passive management.

Active portfolio management

Active portfolio managers take a hands-on approach when making investment decisions. They charge investors a percentage of the assets they manage for you. Their goal is to outperform an investment benchmark (or stock market index, such as the S&P 500).

However, high portfolio management fees can affect investment returns. Clients typically pay 1% of their balance or more per year to cover advisory fees.

» MORE: See how much a financial advisor costs

Passive portfolio management

Passive portfolio management involves choosing a group of investments that track a broad stock market index. The goal is to mirror the returns of the market (or a specific portion of it) over time.

Many people use robo-advisors for passive portfolio management. These services use a computer algorithm to automatically choose and manage investments based on parameters you set, including your goals, time horizon and risk tolerance.

Robo-advisors also charge a percentage of assets managed. But because there is so little hands-on management, it typically costs less than active portfolio management (generally between 0.25% and 0.50% per year).

» View our picks for the best robo-advisors

Portfolio management: Things to keep in mind

Here are some key concepts that can help you choose your investments and manage them wisely.

Asset location

This answers one question: Where are your investments going to live? The type of account you pick will become your investments' home — and there are lots to choose from. The key is to pick the best type of investment account for your goals.

A major part of picking an investment account is choosing between taxable accounts and tax-advantaged ones.

• This decision can have both short-term and long-term tax implications. 

• Consider using designated retirement accounts, such as IRAs and 401(k)s for your retirement savings, because they offer tax advantages. For example, money you contribute to a Roth IRA grows tax-free.

• You may also want to have a standard taxable investment account to invest for nonretirement goals (such as saving for a down payment).

Asset allocation

Asset allocation refers to how your portfolio is divided up between different types of investments. This is usually related to your level of risk tolerance. For instance, if you have many years to go before you retire, you have more time to take risk, and so you can have a larger portion of your portfolio in riskier investments. If you're closer to retirement, you may want to have a larger proportion of less risky investments.

Diversification

Diversification refers to spreading out your investing dollars so you’re not overexposed to the risks posed by any single investment.

• It could mean investing in different types of assets, such as stock and bonds. 

• It can also mean diversifying your investments within a single asset class, such as owning stocks in different geographies, sizes and industries. That way, if one particular industry sinks, your whole portfolio does not. 

• Investing in funds, which are essentially baskets of lots of different securities, provides more diversification than investing everything in a single stock.

Rebalancing

Rebalancing is how portfolio managers stay true to the original target asset allocation. Over time, market fluctuations might cause a portfolio to get off course from its original goals.

Tax minimization

Tax-efficient investing can help avoid pricey surprises from the IRS. These strategies work to offset or lower an investor’s exposure to current and future taxes, which can make or break an investor’s returns.

Putting it all together

Portfolio management in the real world combines all of these aspects into one personalized portfolio. For example, if an investor is planning on retiring in five years and doesn’t want to take much risk, the portfolio management concepts might come together like this:

• Asset location: They have a 401(k) from their employer where they put a portion of their paycheck. 

• Asset allocation: Based on their risk tolerance and proximity of retirement, their portfolio could be 50% stocks and 50% bonds. (Remember, this is just an example.)

• Rebalancing: If the ratio of stocks to bonds changes over time and the investor winds up with a portfolio closer to 55% in stocks, that gives them a riskier portfolio than they are comfortable with. The investor or a portfolio manager would then rebalance the portfolio by buying and selling investments to bring it back to its original 50/50 ratio.

• Tax minimization: By putting pre-tax dollars in a 401(k), this investor is lowering their current tax liability and can work in their favor later if they believe they will be in a lower tax bracket during retirement.

How to manage your own portfolio

Four main factors guide portfolio management decisions.

1. Setting goals.

Your savings goals — such as retirement, a home renovation, a child’s education or family vacation — determine how much money you need to save and what investing strategy and account type is most appropriate to achieve your objectives.

2. Figuring out how much help you want.

Some investors may prefer to choose all their investments; others would be more than happy to let a portfolio manager take over.

3. Mapping out your timeline.

When do you need the money you’re investing, and is that date set in stone or flexible? Your timeline helps inform how aggressive or conservative your investing strategy needs to be. Most investment goals can be mapped to short-, intermediate- and long-term time horizons, loosely defined as three years, three to 10 years and 10 or more years. If, for example, you need the money within three years, you’ll want to minimize your exposure to the short-term volatility of the stock market.

4. Determining your tolerance for risk.

The more risk you’re willing to take, the higher the potential payoff. High-risk investments tend to earn higher returns over time but may experience more short-term volatility. The goal is to strike the right risk-reward balance, picking investments that will help you achieve your goals but not keep you up at night with worry.

Portfolio management vs. wealth management

The main difference between portfolio management and wealth management is that portfolio management deals strictly with a client's investment portfolio and how to best allocate assets to fit their risk tolerance and financial goals. Wealth management is the highest level of financial planning, and often includes services such as estate planning, tax preparation and legal guidance in addition to investment management.