Portfolio management is a critical investment practice used by two types of entities: individual and institutional investors. These categories have distinct strategies, goals, and resources. Understanding the different approaches and needs of these two types of investors can provide greater insight into how portfolio management techniques are applied across the financial spectrum.

Individual investors often focus on personal wealth and future needs, managing smaller amounts of money with varying degrees of professional assistance. In contrast, institutional investors manage large-scale assets with a professional approach tailored to fulfill specific financial obligations and institutional goals. Both groups, however, aim to improve their returns through effective portfolio management tailored to their specific circumstances and financial objectives.

Individual investors have a range of personal goals, risk preferences, and resources. Their objectives include saving for retirement, accumulating wealth for large purchases, funding education for children, or building an emergency fund. Each goal requires a different strategy or risk profile.

The risk tolerance as well as investment knowledge among individual investors varies greatly. In addition, their approach to managing investments can range from highly engaged active trading and rebalancing to relying on automated or professional management. As financial markets have evolved and technology has widened access to investment information, individual investors have had wider prospects to tailor their investment strategies to meet their personal financial objectives.

Institutional investors are entities that pool large sums of money and invest those funds into various financial instruments and assets: pension funds, endowments, foundations, banks, and insurance companies. Each has specific objectives and constraints that influence their portfolio management strategies. Many institutional investors have long-term financial obligations that cause them to focus on long-term growth and sustainability over short-term gains.

In addition, institutional investors are often under strict regulatory oversight to ensure they manage their beneficiaries' funds responsibly. Moreover, ethical and social governance issues increasingly influence their investment decisions. Risk management is a crucial part of the work of an institutional portfolio manager since these entities must balance the need for profitability with the imperative of preserving capital to meet future liabilities.

Institutional investors' investment approaches are typically conservative compared with individual investors, focusing on long-term stability, capital preservation, and meeting future obligations. Indeed, each type of institutional investor has distinct strategies and objectives, but all share the common goal of responsibly managing large pools of capital to meet the needs of their stakeholders.

Portfolio management can be either passive or active.

Approach: Hands-on

Cost Implications: More costly

Performance: Historically, over long periods, underperforms

Approach: Hands-off

Cost Implications: Less costly

Performance: Historically, over long periods, market-performs

Passive management is the set-it-and-forget-it long-term strategy. It may involve investing in one or more exchange-traded (ETF) index funds. This is commonly referred to as indexing or index investing. Those who build indexed portfolios may use modern portfolio theory to help them optimize the mix.

Active management involves attempting to beat the performance of an index by actively buying and selling individual stocks and other assets. Closed-end funds are generally actively managed, as are many mutual funds. Active managers may use any of a wide range of quantitative or qualitative models to aid in their evaluation of potential investments.

Investors who use an active management approach have fund managers or brokers to buy and sell stocks in an attempt to outperform a specific index, such as the Standard & Poor's 500 Index or the Russell 1000 Index. Often, these investors will also use portfolio management software to help them track their investments.

An actively managed investment fund has an individual portfolio manager, co-managers, or a team of managers actively making investment decisions for the fund. The success of an actively managed fund depends on a combination of in-depth research, market forecasting, and the expertise of the portfolio manager or management team.

Portfolio managers engaged in active investing pay close attention to market trends, shifts in the economy, changes to the political landscape, and news that affects companies. This data is used to time the purchase or sale of investments to take advantage of market irregularities. Active managers claim that these processes will boost the potential for returns higher than those achieved by simply tracking the holdings on a particular index.

Trying to beat the market inevitably involves market risk. Indexing eliminates this particular risk, as there is less probability of human error in selecting the index stocks. Index funds are also traded less often, which means that they incur lower expense ratios and are more tax-efficient than actively managed funds.

Passive portfolio management, also referred to as index fund management, aims to duplicate the return of a particular market index or benchmark. Managers buy the same stocks that are listed on the index, using the same weighting that they represent in the index.

A passive strategy portfolio can be structured as an ETF, a mutual fund, or a unit investment trust. Index funds are branded as passively managed because each has a portfolio manager whose job is to replicate the index rather than select the assets bought or sold.

Management fees assessed on passive portfolios or funds are typically far lower than active management strategies.

Another critical element of portfolio management is the concept of discretionary and non-discretionary management. This portfolio management approach dictates what a third-party may be allowed to do regarding your portfolio.

A discretionary or non-discretionary management style is only relevant if you have an independent broker managing your portfolio. If you want the broker to execute trades that you have explicitly approved, you must opt for a non-discretionary investment account. The broker may advise you on strategy and suggest investment moves. However, without your approval, the broker is simply an advisor who must follow your instructions.

Meanwhile, some investors would prefer placing all the decisions in the hands of their broker or financial manager. In these situations, the financial advisor can buy or sell securities without the approval of the investor. The advisor still has a fiduciary responsibility to act in their client's best interest when managing their portfolio.

The key to effective portfolio management is the long-term mix of assets. Generally, that means stocks, bonds, and cash equivalents such as certificates of deposit. There are others, called alternative investments, such as real estate, commodities, derivatives, and cryptocurrency.

Asset allocation is based on the understanding that different types of assets do not move in concert, and some are more volatile than others. A mix of assets provides balance and protects against risk.

Investors with a more aggressive profile weigh their portfolios more toward volatile investments such as growth stocks. Investors with a conservative profile weigh their portfolios toward stabler investments such as bonds and blue chip stocks.

Rebalancing captures recent gains and opens new prospects while keeping the portfolio in line with its original risk-return profile.

The only certainty in investing is that it is impossible to always predict winners and losers. The prudent approach is to create a basket of investments that provide broad exposure across different assets.

Diversification involves spreading the risk and reward of individual securities within an asset class, or between asset classes. Because it is difficult to know which subset of an asset class or sector is likely to outperform another, diversification seeks to capture the returns of different sectors over time while reducing volatility.

Real diversification is made across various classes of securities, sectors of the economy, and geographical regions.

Rebalancing returns a portfolio to its original target allocation at regular intervals, usually annually. This is done to reinstate the original asset mix when the market movements push it out of kilter.

For example, a portfolio that starts with a 70% equity and 30% fixed-income allocation could, after an extended market rally, shift to an 80/20 allocation. Investors have made a good profit, but the portfolio now has more risk than investors with that balance can tolerate.

Rebalancing generally involves selling high-priced securities and putting that money to work in lower-priced and out-of-favor securities. The annual rebalancing exercise allows investors to capture gains and expand their chances for growth in high-potential sectors while keeping the portfolio aligned with the original risk-return profile.

A potentially material aspect of portfolio management relates to how your portfolio is shaped to minimize taxes in the long-term. This is relevant for retirement accounts, how long securities are held on for, and which securities are held.

For example, certain bonds may be tax-exempt. This means that any dividends earned are not subject to taxes. Meanwhile, consider how the IRS had different rules relating to short-term or long-term capital gains taxes. For individuals earning less than $41,675 in 2023, their capital gains rate may be $0. Meanwhile, a short-term capital gains tax of 15% may apply if your income is above this IRS limit.

Portfolios include investments across cash accounts, 401(k)s, IRAs, and other retirement accounts.

Every investor's specific situation is unique. Therefore, while some investors may be risk-averse, others may be inclined to pursue the greatest returns (while also incurring the greatest risk). Very broadly speaking, here are several common portfolio management strategies an investor can consider:

Whatever strategy is chosen, portfolio management always faces several hurdles that often cannot be eliminated entirely. Even if an investor has a foolproof portfolio management strategy, investment portfolios are subject to market fluctuations and volatility. The best management approach can still suffer from significant losses.

Though diversification is an important aspect of portfolio management, it can also be challenging to achieve. Finding the right mix of asset classes and investments to balance risk and return requires an in-depth understanding of the market and the investor's risk tolerance. It may also be expensive to buy a wide range of securities to meet the desired diversification.

To devise the best portfolio management strategy, an investor must first know their risk tolerance, investment horizon, and return expectations. This requires a clear short-term and long-term goal. Because life circumstances can quickly and rapidly change, investors must be mindful of how some strategies limit investment liquidity or flexibility. In addition, the IRS may implement changes to tax regulations that may force you to change your investment strategy.

Lastly, portfolio managers charge fees. The portfolio manager must often meet specific regulatory reporting requirements, and managers may not have the same views of the market as you do.

Determining your risk tolerance involves assessing your willingness and ability to endure market volatility and potential losses. This can be influenced by your financial goals, investment time horizon, income, and personal comfort with risk. Tools like risk tolerance questionnaires can help quantify your risk tolerance by asking about your reactions to hypothetical market scenarios and your investment preferences. In addition, thinking back to your past investment experiences and consulting with a financial advisor can provide a clearer understanding of the kinds of investments that are right for you in terms of your risk tolerance.

Asset allocation involves spreading the investor's money among different asset classes so that risks are reduced and opportunities are maximized. Stocks, bonds, and cash are the three most common asset classes, but others include real estate, commodities, currencies, and crypto. Within each of these are subclasses that play into a portfolio allocation.

If this happens, it's important to avoid panic selling and instead assess the situation calmly. Start by reviewing your investment strategy to ensure it still aligns with your long-term goals and risk tolerance. Consider whether the losses are because of market volatility or fundamental changes in the assets you hold. Rebalancing your portfolio might be necessary to maintain your desired asset allocation. Diversifying your investments can also help mitigate future risks. Consulting with a financial advisor can give you guidance and help you make informed decisions about how to recover from your losses and adjust your strategy if needed.

Evaluating the performance of your portfolio involves comparing its returns against benchmarks (typically indexes that offer a mix like you're aiming for in your portfolio) and considering your investment goals. Data to review include total return, your risk-adjusted return, and the performance of individual assets relative to their respective indexes. It's also important to review the consistency of your returns over time and whether your portfolio is making progress toward your objectives.

Anyone who wants to grow their money has choices to make. You can be your own investment portfolio manager, or you can hire a professional to do it for you. You can choose a passive management strategy by putting your money in index funds. You can also try to beat the markets by actively managing your portfolio.

You'll want to pay attention to the basics of portfolio management: pick a mix of assets to lower your overall risk, diversify your holdings to maximize your potential returns, and rebalance your portfolio regularly to keep the mix right.