What is a Stock Portfolio? How to Use Modern Portfolio Theory?

Discover Key Lessons in Stock Portfolio Management. What is a Stock Portfolio / What is Modern Portfolio Theory

A stock portfolio is a basket of stocks selected to achieve an investing goal, such as growth, value, or income investing. There are many ways to build a stock portfolio, and some important tasks to perform regularly to keep the portfolio in good shape.

In this article, you will discover exactly what a stock portfolio is, and be introduced to the foundation of all professional financial advice, Modern Portfolio Theory.

What is a Stock Portfolio? How Do I Use Modern Portfolio Theory?
What is a Stock Portfolio? How Do I Use Modern Portfolio Theory?

What is a Stock Portfolio?

A stock portfolio is a collection of stocks an investor hopes will protect their assets and make money. Investors usually design portfolios to implement investment strategies. Thus a portfolio often reflects an investors’ philosophy and goals. Therefore, having an investment philosophy and strategy is the first step in building a stock portfolio. A portfolio without a strategy is built to fail.

Most portfolios contain specific amounts of stocks investors buy for certain purposes. A portfolio could contain both growth and dividend stocks, for instance.

Some stock portfolios also contain other kinds of investments. A portfolio could contain 30% bonds or certificates of deposit (CDs) to offer stability, safety, or liquidity.

Many popular portfolios contain both securities (bonds) and equities (stocks or funds). Other portfolios will contain cash in the form of bank accounts or CDs.

Managers place cash in a portfolio to ensure liquidity. Liquidity gives investors funds they can spend fast to take advantage of opportunities or cover emergency expenses.

The most successful stock portfolios are designed for specific individuals. For instance, a portfolio full of Blue Chip dividend stocks will serve a conservative individual. However, a portfolio of tech growth stocks will better serve a risk-taker.

Many experts recommend growth-stock portfolios for younger investors or those who need more income. The same experts will recommend portfolios full of dividend stocks or Blue Chip stocks for older investors and people who need to protect assets.

Thus a good way to think of portfolios is as investment strategies and expressions of investment philosophy. Another way to think of stock portfolios is as a means of protecting money and preserving assets.

What is Modern Portfolio Theory?

Economist Harry Markowitz won a Nobel Prize for creating Modern Portfolio Theory (MPT). Markowitz proposed Modern Portfolio Theory in a 1952 paper called Portfolio Selection in the Journal of Finance. Markowitz believes that it is a mistake for people to view investments as standalone products. Instead, Markowitz teaches that you must always view investments as part of a portfolio.

Under MPT, you must view investments as pieces of a pie rather than one-time purchases. Hence, under MPT, you purchase investments because they enhance the portfolio.

If you want more security for the portfolio, MPT teaches that you must purchase low-risk stocks or bonds. If you need more income, you need to add more growth stocks or dividend stocks to the portfolio.

The basis of Modern Portfolio Theory (MPT) is diversification. Diversification means buying several different kinds of stocks and securities to reduce risks and maximize gains.

An MPT portfolio will always be diversified. The pie-chart pictures of portfolios you see in investment prospectuses and online are an expression of MPT.

Many modern investment products, including mutual funds, Exchange Traded Funds (EFTs), annuities, 401K Retirement Plans, Individual Retirement Accounts (IRAs), superannuation accounts, and some CDs use variations of Modern Portfolio Theory. Most of the retirement accounts popular in the United States and Australia utilize MPT.

Some observers will argue that MPT is the basis of the modern fund management profession and the mutual fund and hedge fund industries. Many fund managers, whose pictures grace mutual fund prospectuses, use variations of MPT to control their clients’ funds.

Thus, Modern Portfolio Theory has become one of the cornerstones of contemporary investing. Many investors employ MPT each day without realizing it.

An understanding of Modern Portfolio Theory can help you understand how today’s markets work. MPT affects the entire market because enormous institutional investors base most of their decisions on modern portfolio theory.

Most investors create portfolios today because of MPT. Without MPT, today’s stock market would be a very different place.

Giant fund managers, such as Vanguard, might not exist without MPT. Vanguard claimed to serve over 30 million customers in 170 countries in 2020. Thus, tens of millions of people use MPT to access the stock market and manage their funds.

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