Portfolio Strategy

The strategy of dividing investments among different asset classes (stocks, bonds, cash) to balance risk and return based on investment objectives, time horizon, and risk tolerance. Research shows asset allocation determines over 90% of portfolio return variability over time.

Example: A 60/40 portfolio allocates 60% to stocks and 40% to bonds, balancing growth potential with stabilit...

A statistical measure of how two securities move together, indicating the direction of their relationship but not its strength. Positive covariance means securities tend to move in the same direction, negative covariance means they move in opposite directions, and zero covariance indicates no linear relationship. Used in Modern Portfolio Theory for portfolio construction and diversification analysis, though correlation is preferred for interpretation because covariance magnitude depends on the securities being measured.

Example: If Stock A and Stock B have positive covariance, when Stock A rises 5%, Stock B tends to rise as wel...

The practice of spreading investments across different securities, sectors, or asset classes to reduce unsystematic risk. Does not eliminate systematic (market) risk. Effective diversification requires low or negative correlation between holdings.

Example: A portfolio with 60% stocks (across 8 sectors), 30% bonds, and 10% real estate provides diversificat...

An investment strategy of investing a fixed dollar amount at regular intervals (weekly, monthly, quarterly) regardless of share price. Automatically purchases more shares when prices are low and fewer shares when prices are high, resulting in a lower average cost per share over time compared to the average share price.

Example: An investor commits to investing $500 monthly in a mutual fund. In January, shares cost $25 (buys 20...

A written document that establishes a client's investment objectives, risk tolerance, time horizon, constraints, strategic asset allocation, and rebalancing procedures. Serves as the roadmap for portfolio management, guiding all investment decisions and ensuring alignment with client goals. Must be reviewed and updated when client circumstances change (retirement, inheritance, marriage, job change).

Example: An IPS for a 45-year-old professional might specify: objective (retirement in 20 years), risk tolera...

An investment strategy involving the purchase of bonds or CDs with staggered maturity dates spread across different time periods. Laddering manages interest rate risk by avoiding concentration at a single maturity point, provides regular liquidity as securities mature periodically, and smooths out reinvestment risk by spreading reinvestment opportunities across multiple time periods rather than reinvesting all funds at once.

Example: An investor with $100,000 purchases five bonds of $20,000 each maturing in 2, 4, 6, 8, and 10 years....

Owning a security or holding the right to buy it, with the expectation that its price will increase. For stocks, a long position means owning shares outright, with profit potential unlimited (as price rises) and maximum loss limited to the purchase price (if price falls to zero). For options, being long a call gives the right to buy at the strike price, while being long a put gives the right to sell, with maximum loss limited to the premium paid. Long positions reflect a bullish market outlook.

Example: An investor purchases 100 shares of ABC stock at $50 per share, establishing a long position worth $...

A framework developed by Harry Markowitz for constructing portfolios that maximize expected return for a given level of risk through diversification. MPT emphasizes that risk can be reduced by combining assets with low or negative correlation, and that portfolios should be evaluated based on their overall risk-return characteristics rather than individual securities in isolation. The efficient frontier represents the set of optimal portfolios offering the highest expected return for each risk level.

Example: An adviser using MPT principles constructs a client portfolio with 60% stocks and 40% bonds. The bon...

The annual rate at which a fund or portfolio buys and sells holdings, expressed as a percentage. Calculated as total purchases divided by average portfolio value. High turnover (over 100%) indicates active trading with higher costs and tax consequences, while low turnover (under 25%) indicates a buy-and-hold strategy with lower expenses.

Example: An actively managed growth fund with $100 million in assets purchases $120 million in new securities...

The percentage deviation from target strategic asset allocation that triggers portfolio rebalancing. For example, if strategic allocation is 60% stocks with a 5% threshold, rebalancing occurs when stocks drift to 65% or 55%. This returns the portfolio to its strategic allocation, not a tactical adjustment based on market views.

Example: A client has a 60% stock / 40% bond portfolio with a 5% rebalancing threshold. After a strong market...

The ability and willingness to withstand investment losses and volatility, comprising TWO components: (1) Risk CAPACITY - the financial ability to take risk based on time horizon, income needs, and net worth, and (2) Risk WILLINGNESS - the psychological comfort with volatility and potential losses. Suitability requires assessing BOTH, and the LOWER of capacity or willingness determines the appropriate risk level for investment recommendations.

Example: A 28-year-old software engineer earning $180,000 annually with 35+ years until retirement has HIGH r...

An active investment strategy that shifts portfolio allocations among different economic sectors based on business cycle phases. Certain sectors (technology, consumer discretionary) typically outperform during expansion while others (utilities, consumer staples, healthcare) perform better during contraction.

Example: As economic indicators signal recession, a portfolio manager reduces technology and consumer discret...

An order that becomes a market order once a specified stop price is reached. Buy stop orders are placed above the current market price to protect short positions or enter on breakouts; sell stop orders (stop-loss orders) are placed below the current market price to protect long positions or limit losses. Once triggered, the order executes at the next available price with no price guarantee.

Example: An investor owns stock currently trading at $50 and wants downside protection. They enter a sell sto...

The long-term target mix of asset classes (stocks, bonds, cash) in a portfolio based on the client's risk tolerance, time horizon, and financial objectives. This baseline allocation typically remains stable over years and is not adjusted for short-term market conditions or forecasts. Strategic allocation is typically documented in the Investment Policy Statement (IPS) and serves as the portfolio's foundation, with periodic rebalancing to maintain target percentages.

Example: An adviser establishes a strategic allocation of 60% stocks, 30% bonds, and 10% cash for a 45-year-o...

A short-term, active investment strategy that makes temporary deviations from the strategic (baseline) asset allocation to capitalize on market opportunities or avoid market risks. Unlike strategic allocation which sets long-term target percentages, tactical allocation involves making temporary adjustments based on current economic conditions, market valuations, or near-term outlook, with the intention of returning to the strategic allocation once conditions change.

Example: A client has a strategic allocation of 60% stocks / 40% bonds. Based on concerns about an impending ...

The length of time until a client needs to access invested funds. Longer time horizons (typically 10+ years) allow for more aggressive allocations with higher equity exposure because there is time to recover from market downturns. Shorter time horizons (under 3 years) require more conservative allocations to preserve capital and ensure funds are available when needed.

Example: A 28-year-old saving for retirement at age 65 has a 37-year time horizon, allowing for an aggressive...