As a new investor, you may be eager to start building an investment portfolio. Regular portfolio analysis is vital for your success.
What is Portfolio Analysis?
Portfolio analysis is the process of studying an investment portfolio to determine whether it meets the needs, preferences, and resources of a specific investor. It also measures the likelihood of achieving the specified investment objectives and principles. This is done based on the risk rate, considering factors such as past asset class performance and inflation rates.
How Does Portfolio Analysis Work?
To analyze a portfolio, you need to know the types of assets and their characteristics. For example, you may ask a registered investment advisor or asset management company to review your portfolio, knowing that you need to preserve capital for five years. For this purpose, the advisory firm will examine your portfolio to assess whether it is likely to maintain its value and be liquid enough for withdrawal when needed.
In this case, the advisory firm would want to avoid any significant risks in stocks due to the potential for price fluctuations. Instead, it would focus on cash-equivalents and non-volatile options, such as cash, money market funds, certificates of deposit, bonds, and U.S. Treasury securities, among other similar investments.
How Does Your Portfolio Perform as a Whole?
The first step is to look at the portfolio as a whole. The goal is to see how the portfolio is positioned relative to other portfolios or a relevant index. In the case of a portfolio containing only stocks, this can mean considering the total number of components in the portfolio. This includes the price-to-earnings ratio for the portfolio as a whole, the dividend yield for the portfolio as a whole, and the expected earnings growth rate per share. Then compare these figures to a stock market index such as the S&P 500 or Dow Jones Industrial Average.
How Do Your Assets Relate to Each Other?
The second step is to examine the portfolio components relative to each other. The goal of this step is to understand how each component in the portfolio is affected by the others, whether directly or indirectly. You also consider how other factors impact each asset separately.
For example, let’s take a look at the second-largest Dairy Queen franchise operator in the United States, Vasari LLC. In October 2017, it announced it was seeking bankruptcy protection. Falling oil prices resulted in income losses among communities where many of its restaurants are located, leading the company to close several locations, mainly in Texas.
Any investor holding a stake in this franchise operator would significantly increase their risk if they also had stakes in the largest oil companies (the major oil firms). These stocks could be held in a taxable brokerage account or a Roth retirement account.
How Do Your Assets Perform Separately?
Your third task is to review portfolio components as separate investments. As you analyze each one, ask yourself:
- Why do I own this investment?
- What are my expectations for after-tax cash flows compared to the price I paid?
- Under what terms or conditions do I hold this position?
This step can prevent many mistakes from entering your budget, and it is crucial for risk management. Sometimes, Wall Street and investors get swept up in an irrational wave. They begin to believe that they must own a particular company, sector, or industry that is currently popular.
A financial advisor may review the portfolio and find that the predefined asset allocation for the investor includes a low-cost bond exchange-traded fund. The problem here is that after digging into the ETF’s files, the advisor discovers that some of the bonds held by the fund are high-risk bonds for loans to third-world countries.
In
In such a case, it would be less risky to earn a little less money by holding investment-grade corporate bonds. They are safer than sending your precious capital to the middle of the world in the debt securities of a country that has a real chance of being unable to pay its bills.
Institutional Portfolio Analysis is More Complex
Institutional investors can perform several other operations to analyze the portfolio when evaluating the assets under management.
For example, many portfolio managers prefer to conduct dated stress tests to see how a particular portfolio would likely perform under various economic or market conditions. They may simulate the frequency of the Great Depression, the stock market crash of 1987, the Asian financial crisis of 1997, or the Great Recession that began in December 2007.
On the institutional level, professional service providers like Bloomberg and FactSet offer products that allow for running these simulations in almost real-time. Another option is to run them automatically according to a schedule set by the portfolio manager or the investment committee of the asset management firm.
An investment advisory firm appointed to invest retained capital in a pension fund will want to ensure that the assets in the portfolio are compliant and suitable. Pension funds are subject to many laws and regulations, such as the Employee Retirement Income Security Act of 1974 (ERISA).
The same applies to the trustee of a trust fund, who must regularly ensure that trust assets and transactions, including any distributions or payments, are carried out according to the trust deed.
Source: https://www.thebalancemoney.com/portfolio-analysis-for-beginners-4154345
Leave a Reply