The Most Neglected Aspects of Portfolio Management

Portfolio-Management


Portfolio Management
  is the scientific art of managing investor money based on sound investing principles. 

Investors either manage their own portfolios or seek the help of a financial expert who can manage their portfolios. In either case, some critical aspects of portfolio management are neglected many times.

This article discusses the 3 most neglected aspects of portfolio management and why they are as crucial as risk and returns.

Fees and Costs of Investment Portfolio

Investing is, sadly, not free. There are many types of fees or costs that you have to pay to invest. 

Because these fees are generally deducted from your investments, you don’t realise how much you pay to different entities like brokers, AMCs, advisors, and portfolio managers.

It starts with the transaction fees. Your broker probably charges you a transaction fee whenever you buy or sell a security.

If you invest in mutual funds, you pay an expense ratio to the mutual fund for managing your money.

If you invest in mutual funds through a distributor, you pay the distributor a commission or brokerage as long as you stay invested.

Even if you invest in mutual funds through the direct route, you pay the RIA or PMS a management fee + performance fee.

Similar fees are applicable if you invest in a stock portfolio.

Simply put, the net return on your portfolio (after fees) can be quite different from the gross return generated by the portfolio. So, you and your financial advisor need to keep a close look at the fees and costs of your portfolio and strive towards minimising them.

Post-tax Return of Securities Considered

Suppose there are two securities: E and D. The expected returns from E and D are 12% and 14%, each with roughly similar risks. What security will you invest in?

Most would quickly select and invest in D because it is expected to generate a 14% return against E, which is expected to return a 12% return. But what if we told you that the tax on D’s return is 40%, whereas the tax on E’s return is just 10%?

This means on a post-tax basis, D is expected to return 9.4%, whereas E is expected to return 10.8% to you. With similar risk levels, wouldn’t it make more sense to invest in E?

HNIs and institutional investors rarely think in gross return terms. They always think in post-tax and post-fee return terms because the absolute fee and tax they pay because of their large portfolio size matters.

But let’s not forget that fees and taxes are generally quoted in percentage terms. So, they affect small as well as large portfolios equally. So, there is no reason to neglect these aspects even if your portfolio is not as large as those of HNIs and institutional investors.

Liquidity of the Overall Portfolio

Liquidity is how quickly something can be converted into cash without losing its market value.

Portfolios are composed of different investment instruments like mutual funds, stocks, bonds, unlisted equity, real estate, etc. The liquidity of each of these instruments differs for various reasons.

Large-cap stocks can be bought and sold on stock exchanges at will. But small-cap stocks don’t enjoy the same luxury.

Mutual fund units can be bought and sold at will because the buying and selling of underlying securities is the mutual fund’s headache. However, real estate cannot be bought and sold easily because the discovery of the right property/buyer and the operational aspect takes time.

Portfolios should be liquid based on an individual’s overall financial position.

For example - The portfolio of a salaried professional need not be liquid because they earn a regular income that takes care of their expenses. But, the portfolio of a businessman should have a level of liquidity that takes into account the uncertainty of their business cash flows.

So, you should not put 100% of your money in illiquid assets (like unlisted equity and real estate) or considerably volatile assets (stocks and long-duration bonds) and keep some liquidity provision that may be required for various reasons based on your financial position.

Unlike risk and returns, fees, costs, taxes, and liquidity are some of the most neglected aspects of investing.

However, this shouldn’t be so because aspects like fees, costs, and taxes directly affect your net returns, whereas factors like liquidity impact the risk of your investment portfolios and your overall personal finance.

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