Portfolio Management Basics: Building Wealth Over Time

Successful investing isn’t just about picking individual stocks—it’s about building and managing a portfolio that aligns with your goals, risk tolerance, and time horizon. This guide covers the essential principles of portfolio management.

What is Portfolio Management?

Portfolio management is the art and science of making decisions about investment mix, matching investments to objectives, balancing risk against performance, and asset allocation for individuals and institutions.

Key Objectives

1. Grow wealth over time through capital appreciation and income
2. Manage risk to avoid devastating losses
3. Generate income if needed for living expenses
4. Preserve capital during market downturns
5. Achieve specific goals (retirement, education, major purchase)

Foundation: Know Yourself

Before building a portfolio, answer these critical questions:

What are your goals?

• Time horizon: When will you need the money?

  • Short-term (< 3 years): House down payment, car purchase
  • Medium-term (3-10 years): Education funding, business start
  • Long-term (> 10 years): Retirement, wealth building

• Purpose: What is the money for?

  • Retirement income
  • Wealth accumulation
  • Legacy planning
  • Financial independence

What’s your risk tolerance?

Risk capacity (objective ability to take risk):

• How much can you afford to lose?
• What’s your job security?
• Do you have emergency savings?
• What are your other assets and income sources?

Risk tolerance (emotional comfort with volatility):

• How would you react to a 20% portfolio decline?
• Can you stay invested during bear markets?
• Do daily fluctuations cause stress?
• Have you invested through market downturns before?

What’s your investment knowledge?

• Beginner: Stick to simple, diversified approaches
• Intermediate: Can analyze individual stocks and more complex strategies
• Advanced: Comfortable with sophisticated techniques and alternative investments

Strategic Asset Allocation

Asset allocation is the most important determinant of portfolio returns—more important than individual security selection.

Major Asset Classes

1. Stocks (Equities)

Purpose: Long-term growth

Characteristics:

• Higher expected returns (historically ~10% annually)
• Higher volatility (can drop 50%+ in severe bear markets)
• No guaranteed returns
• Liquid (easy to buy and sell)

Typical allocation: 60-100% for long-term growth portfolios

Sub-categories:

• Domestic vs. international
• Large-cap vs. small-cap
• Growth vs. value
• Sectors (technology, healthcare, etc.)

2. Bonds (Fixed Income)

Purpose: Income and stability

Characteristics:

• Lower expected returns (~5% historically)
• Lower volatility than stocks
• Regular income through interest payments
• Inverse relationship with interest rates

Typical allocation: 10-40% depending on age and goals

Sub-categories:

• Government vs. corporate
• Short-term vs. long-term
• Investment grade vs. high yield
• Domestic vs. international

3. Cash and Cash Equivalents

Purpose: Liquidity and safety

Characteristics:

• Very low returns (slightly above inflation if lucky)
• Virtually no volatility
• Immediate liquidity
• Lose purchasing power over time

Typical allocation: 5-10% for emergency fund and opportunities

Types:

• Savings accounts
• Money market funds
• Treasury bills
• Certificates of deposit (CDs)

4. Alternative Investments (Advanced)

Purpose: Diversification and unique return sources

Types:

• Real estate (REITs or direct ownership)
• Commodities (gold, oil, etc.)
• Private equity
• Hedge funds
• Cryptocurrencies

Typical allocation: 0-10% for sophisticated investors

Sample Asset Allocations by Age and Risk Tolerance

Aggressive (Young, High Risk Tolerance)

• 85% Stocks (60% US, 25% International)
• 10% Bonds
• 5% Cash

Moderate (Middle Age, Balanced)

• 65% Stocks (45% US, 20% International)
• 30% Bonds
• 5% Cash

Conservative (Near Retirement, Low Risk)

• 40% Stocks (30% US, 10% International)
• 50% Bonds
• 10% Cash

Income-Focused (Retirement, Need Income)

• 30% Dividend Stocks
• 60% Bonds (mix of government and corporate)
• 10% Cash

The Age-Based Rule of Thumb

A simple guideline: Bond allocation = Your age

• Age 30: 30% bonds, 70% stocks
• Age 50: 50% bonds, 50% stocks
• Age 70: 70% bonds, 30% stocks

However, this rule is becoming outdated as life expectancies increase. Many advisors now suggest:

Modified rule: Bond allocation = Your age minus 20

• Age 30: 10% bonds, 90% stocks
• Age 50: 30% bonds, 70% stocks
• Age 70: 50% bonds, 50% stocks

Building Your Portfolio

Step 1: Determine Your Asset Allocation

Based on your goals, time horizon, and risk tolerance, choose your target allocation:

Example: Moderate 30-year-old investor

• 75% Stocks
• 20% Bonds
• 5% Cash

Step 2: Diversify Within Each Asset Class

For stocks, diversify across:

• Geography: 60% US, 15% developed markets, 10% emerging markets
• Market cap: 60% large-cap, 25% mid-cap, 10% small-cap
• Sector: Spread across 8-10 sectors
• Style: Mix of growth and value

For bonds, diversify across:

• Duration: Short, intermediate, and long-term
• Credit quality: Investment grade and some high yield
• Type: Government, corporate, municipal

Step 3: Choose Your Implementation Approach

Option A: Index Funds and ETFs

Pros:

• Simple and easy to manage
• Low costs
• Automatic diversification
• No need to pick individual stocks

Cons:

• No potential to outperform the market
• No customization to your specific preferences
• You own everything in the index (including companies you might not want)

Example portfolio:

• 50% Total US Stock Market Index
• 15% Total International Stock Index
• 10% Small Cap Index
• 20% Total Bond Market Index
• 5% Cash

Option B: Individual Stocks and Bonds

Pros:

• Complete control over holdings
• Can focus on your highest conviction ideas
• Tax optimization opportunities
• Potential to outperform

Cons:

• Time-intensive research required
• Higher risk if not properly diversified
• More expensive (trading costs)
• Requires significant knowledge

Recommendation: Most investors should use a combination—core index funds supplemented with individual stocks you’ve researched.

Option C: Active Mutual Funds

Pros:

• Professional management
• May outperform in certain markets
• Research team and resources

Cons:

• Higher fees (typically 0.5-1.5% annually)
• Most underperform index funds long-term
• Tax inefficiency
• Manager risk

Step 4: Implement Your Plan

1. Open appropriate accounts:

   • Tax-advantaged: 401(k), IRA, Roth IRA
   • Taxable brokerage account

2. Fund your accounts:

   • Emergency fund first (3-6 months expenses)
   • Max out 401(k) match (free money)
   • Max out IRAs
   • Additional savings to taxable accounts

3. Make your purchases:

   • Buy your chosen investments
   • Consider dollar-cost averaging for large lump sums
   • Don’t try to time the market

Portfolio Management: Ongoing Activities

Rebalancing

Over time, your allocations will drift from targets as investments perform differently.

Example:

• Target: 70% stocks, 30% bonds
• After a year: 80% stocks, 20% bonds (stocks outperformed)

Rebalancing means selling winners and buying losers to return to your target allocation.

Rebalancing Methods

Time-based:

• Annually, semi-annually, or quarterly
• Pro: Simple and systematic
• Con: May rebalance when not needed

Threshold-based:

• Rebalance when allocations drift 5-10% from targets
• Pro: Only acts when necessary
• Con: Requires monitoring

Hybrid:

• Check quarterly, rebalance if threshold exceeded
• Balances both approaches

Rebalancing Tips

• Use new contributions to rebalance (no selling needed)
• Prioritize tax-advantaged accounts for rebalancing (avoid capital gains)
• In taxable accounts, use tax-loss harvesting opportunities
• Don’t over-rebalance (trading costs and taxes can exceed benefits)

Tax Management

Minimize taxes to keep more of your returns:

Location optimization:

• Tax-inefficient assets (bonds, REITs) in tax-advantaged accounts
• Tax-efficient assets (index funds, stocks held long-term) in taxable accounts

Harvesting losses:

• Sell losing positions to offset gains
• Maintain exposure by buying similar (but not identical) investments
• Can offset up to $3,000 of ordinary income annually

Hold periods:

• Long-term capital gains (> 1 year) taxed at lower rates
• Short-term gains taxed as ordinary income

Dividend strategy:

• Qualified dividends taxed at lower rates
• Consider dividend-paying stocks for long-term holdings

Performance Monitoring

Track your portfolio’s performance, but don’t obsess:

What to monitor:

• Overall portfolio return
• Return vs. appropriate benchmark
• Allocation vs. targets
• Individual holding performance
• Risk metrics (volatility, maximum drawdown)

How often:

• Daily: Usually counterproductive and stressful
• Monthly: Reasonable for engaged investors
• Quarterly: Sufficient for most
• Annually: Minimum recommended frequency

Benchmarking:

• Compare to appropriate blended benchmark
• Example: 70/30 portfolio vs. 70% S&P 500 + 30% bond index
• Don’t compare to irrelevant benchmarks (70/30 portfolio vs. 100% stock index)

Regular Reviews

Quarterly reviews:

• Check allocation vs. targets
• Review individual holdings for major changes
• Rebalance if needed

Annual deep dive:

• Revisit goals and risk tolerance
• Review overall strategy
• Consider tax planning opportunities
• Assess need for allocation changes
• Review fees and expenses

Life event reviews:

• Marriage or divorce
• Birth of child
• Job change or loss
• Inheritance
• Approaching retirement

Risk Management

Diversification (Revisited)

Your first and best defense against risk:

• Across asset classes
• Within asset classes
• Geographic diversification
• Sector diversification
• Market cap diversification

Position Sizing

General guidelines:

• No single stock more than 5% of portfolio
• No single sector more than 25% of portfolio
• No single position you can’t afford to lose
• Higher concentration only for high-conviction, well-researched ideas

Emergency Fund

Maintain 3-6 months of expenses in cash:

• Prevents forced selling during downturns
• Provides peace of mind
• Covers unexpected expenses
• Allows you to stay invested

Avoid Emotional Decisions

Common emotional mistakes:

• Panic selling in bear markets
• Chasing recent winners
• Overconfidence after wins
• Analysis paralysis (unable to make decisions)
• Anchoring to purchase prices

Solutions:

• Have a written investment plan
• Automate investments (dollar-cost averaging)
• Limit portfolio checking during volatility
• Focus on long-term goals
• Consider working with an advisor

Common Portfolio Management Mistakes

1. No Clear Plan

• Random investment choices
• No consistent strategy
• Decisions driven by emotions or tips

2. Over-trading

• Chasing performance
• Market timing attempts
• High transaction costs
• Tax inefficiency

3. Ignoring Fees

• 1% annual fee = 25% less wealth over 30 years
• Always consider expense ratios
• Minimize trading costs
• Watch for hidden fees

4. Poor Diversification

• Too concentrated in employer stock
• All assets in domestic stocks
• Lack of sector diversification
• Over-concentration in recent winners

5. Forgetting About Taxes

• Ignoring tax implications
• Inappropriate asset location
• Missing tax-loss harvesting opportunities
• Short-term trading in taxable accounts

6. Setting and Forgetting

• Never rebalancing
• Not adjusting for life changes
• Ignoring portfolio drift
• Keeping outdated positions

Advanced Portfolio Concepts

Factor Investing

Targeting specific return drivers:

• Value: Cheap stocks (low P/E, P/B)
• Momentum: Stocks with positive price trends
• Quality: Profitable, stable companies
• Size: Small-cap premium
• Low volatility: Defensive stocks

Core-Satellite Approach

• Core (70-80%): Low-cost index funds
• Satellite (20-30%): Higher conviction individual stocks or specialized strategies

Balances diversification with opportunity to outperform.

Risk Parity

Allocate based on risk contribution, not dollar amounts:

• Bonds get larger allocation (less volatile)
• Stocks get smaller allocation (more volatile)
• Goal: Each asset class contributes equally to portfolio risk

Tactical Asset Allocation

Make temporary deviations from strategic allocation based on market views:

• Example: Reduce stocks before expected recession
• Requires strong market timing ability (difficult)
• Most investors better off with strategic allocation

Using Luna Capital for Portfolio Management

Luna Capital’s tools can enhance your portfolio management:

Portfolio Analysis

• Upload or link your portfolio for comprehensive analysis
• Identify concentration risks
• Get diversification suggestions
• Monitor correlations between holdings

Stock Discovery

• Find opportunities in underrepresented sectors
• Identify potential replacements for underperforming holdings
• Discover companies with strong analytical outlooks

Risk Monitoring

• Track portfolio-level risk metrics
• Get alerts on significant changes to holdings
• Monitor sector and style exposures

AI Insights

• Leverage AI analysis for portfolio holdings
• Compare holdings to alternatives
• Stay informed on portfolio developments

Conclusion

Portfolio management is a long-term endeavor requiring discipline, patience, and periodic attention—but not constant tinkering. Key takeaways:

1. Asset allocation matters most - Get this right first
2. Diversify broadly - Don’t put all eggs in one basket
3. Keep costs low - Every dollar in fees is a dollar not compounding
4. Manage taxes - Keep more of what you earn
5. Rebalance periodically - Maintain your risk profile
6. Stay disciplined - Stick to your plan through market cycles
7. Focus on what you control - Allocation, costs, taxes, behavior

Remember: The best portfolio is one you can stick with through market ups and downs. Simplicity often beats complexity, and consistency beats trying to time the market.

Action Steps:

1. Define your investment goals and time horizon
2. Assess your risk tolerance honestly
3. Create your target asset allocation
4. Build your portfolio using low-cost index funds or diversified individual stocks
5. Set up automatic contributions if possible
6. Establish a rebalancing schedule
7. Review and adjust as life circumstances change

Next: Explore Luna Capital’s portfolio tools to analyze your current allocation and identify opportunities for improvement.