What is a financial portfolio?

A financial portfolio is a set of investments made by an individual or an organisation, for example, to preserve or increase their capital. This investment tool encompasses diverse assets, including stocks, bonds, cash, real estate, works of art, and other financial instruments.

The goal of building an investment portfolio is to ensure a balance between risk and return by diversifying investments. Diversification helps reduce the risk of losses and increases the chances of successful investing, especially in volatile market conditions.

Primary goals of building a financial portfolio

  • Capital growth – increasing the initial capital by investing in assets whose prices may rise over time
  • Yield – obtaining regular income from investments, for example, through dividends from stocks or interest from bonds
  • Capital preservation – protecting invested capital from losses or inflation
  • Risk diversification – distributing investments across different assets to reduce the portfolio’s overall risk level
  • Achieving specific financial goals – accumulating funds for education, real estate purchase, or retirement planning

Types of financial portfolios

  • Conservative portfolio – this is characterised by low risk and mostly comprised of government and corporate bonds with high credit ratings. Such a portfolio may include dividend-paying stocks with low volatility. The goal is to preserve capital and minimise potential losses
  • Aggressive portfolio – typically consists of growth shares, venture projects, and other assets with potentially high returns. The aim is to maximise profits even with an elevated level of risk
  • Mixed portfolio – this type may include the whole possible range of financial assets, from equities to real estate. This is an investor’s attempt to find a middle ground between aggressive and conservative portfolio types to achieve a balance between risk and potential returns
  • Index portfolio – typically consists of investments in index funds. The goal is to track overall market performance while minimising active portfolio management
  • Sectoral portfolio – this is based on investments in shares and other financial instruments only in a particular economic sector or industry. The goal is to generate the highest possible return in anticipation of the impressive development of a specific sector
  • Pension portfolio – this is characterised by a long investment period and the need to rebuild the structure from aggressive to more conservative investments over time. The goal is to accumulate funds to ensure financial security and generate income during retirement

Portfolio management strategies

  • Diversification – spreading investments across different assets to reduce the portfolio’s overall level of risk. This helps minimise potential losses from adverse effects on certain investments
  • Portfolio rebalancing – adjusting ratios of various assets in the portfolio regularly to keep the targeted risk level and investment goals
  • Active management – searching for and selecting specific investments based on a market analysis
  • Passive management – investing in index funds or other investment instruments without active selection

Methods of assessing financial portfolio performance

  • Return on Investment assesses portfolio returns against invested funds
  • Sharpe Ratio assesses portfolio yield in relation to the risk level
  • Treynor Ratio assesses the ratio between the return on the portfolio and systematic risk
  • Alpha and Beta ratios – Alpha shows excess return on the portfolio compared to the market, while Beta signals the portfolio’s sensitivity to market fluctuations
  • Markowitz Method optimises the portfolio to find a perfect risk-yield relationship
  • Jensen’s Alpha assesses portfolio performance considering the share of risk and return
  • Calmar Ratio measures portfolio performance in terms of its volatility
  • Maximum Drawdown shows the portfolio’s maximum losses from the time it reaches its peak value to its lowest trough