Managing a Stock Portfolio
Stocks usually are part of a broader investment portfolio that includes bonds, mutual funds and other assets. Investors who manage their own stock portfolios are essentially their own professional money managers. This means they should be assessing the extent to which their short-term and long-term financial objectives are being met, researching the fundamentals of individual stocks, adjusting the portfolio as required and protecting the portfolio against market fluctuations.
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Objectives
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Investors should continually assess whether their financial objectives are being met. This may involve comparing their stock portfolio return against major market indexes, such as the Dow Jones Industrial Average, which is an index of 30 prominent U.S. companies. If the investment objectives have changed, which can happen if an investor decides to take early retirement, the suitability of the stock mix in the portfolio should be evaluated against the financial objectives.
Research
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Research should include reading a cross-section of the business media sources everyday, starting with "The Wall Street Journal" and the business section of "The New York Times." This helps investors stay current on the latest corporate news and gain valuable perspective on daily stock market gyrations. Investors also can emulate chairman of Berkshire Hathaway, Warren Buffett. In the book "The Warren Buffett Way," author Robert G. Hagstrom writes that Buffett positions his portfolio so he only has to make a few smart decisions: In short, managing a few high-quality stocks is simpler than managing dozens of stocks. Buffett looks for businesses with a lengthy and profitable track record, solid long-term prospects, clear competitive advantages and candid senior management. Buffett likes to buy stocks at a deep discount to what they are worth: If a company's fundamentals are sound, the best time to buy its stock is when the market is in a panic mode and investors are rushing for the exits.
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Adjustments
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Adjustments to a portfolio include reallocation, which changes the stock mix, and rebalancing, which returns the portfolio to the original mix. Reallocation is required if individual stocks are not performing as expected or if the investment time horizon has changed. For example, investors approaching retirement may invest in more conservative stocks, such as utilities, and even increase the percentage of bonds and money market assets in their overall investment portfolio. Rebalancing may be needed when some stocks appreciate faster than others. For example, if the price appreciation of technology stocks changes their proportion in a portfolio from 20 to 30 percent, one rebalancing option would be to sell some of the technology holdings to bring the technology proportion back to 20 percent. Another rebalancing option might be to invest additional funds in non-technology stocks, which would also lower the technology proportion in the portfolio.
Hedging
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Hedging strategies to protect stock portfolios include diversification, which involves investing in stocks from different industries, and options. An option contract gives the holder the right, but not the obligation, to buy (call option) or sell (put option) the underlying security at a specific price, called the strike price, on or before an expiration date. A simple hedging strategy involves buying put options: If the stock falls, the put options rise in value, thus protecting the investor from losses.
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References
- U.S. Securities and Exchange Commission: Beginners' Guide to Asset Allocation, Diversification and Rebalancing
- U.S. Securities and Exchange Commission: Financial Navigating in the Current Economy -- Ten Things to Consider Before You Make Investing Decisions
- Wiley; The Warren Buffett Way; Robert G. Hagstrom; 1994 (Pages 227 to 233)
- The Options Industry Council: Getting Started in Options
