Intro to Portfolio Theory

A portfolio is simply a collection of securities that you own, and hold in one account. Most investors have more than one portfolio because they have more than one account. For example, you might have an IRA account held by a brokerage firm like Fidelity or Vanguard. Then you might also have a taxable account held by the same broker or maybe a different one. You might have a 401k plan at work, which is held at yet another broker. And so on.

Portfolios are a collection of similar things, in this case financial assets. Financial assets are securities, like stocks, bonds, ETFs, CDs, Treasury bills, etc. How many portfolios do you have?

Whether you have one, two or ten portfolios doesn't matter. What matters is that each portfolio has its own unique structure. This structure can be described in several ways, and it is very important for you to have at least a rough idea about the nature of each portfolio that you own.

Depending on which types of securities you own, and how much of your total portfolio's value is invested in each security, one way to describe your portfolio is to measure how risky it is. There are several ways to measure risk, and we will discuss that in a later lesson. 

So now you have two things you know about each of your portfolios - how much they're worth and how risky they are. You should also have at least a rough idea of what each of your securities actually are. For stocks you should know what business they're in, how large the company is, how fast they have been growing, and what you think about their prospects for future growth.

For bonds, you should know who is responsible for making the interest payments, and who will pay you off when the bond matures. Is it the federal government? A corporation? A municipality? Each of these issuers carries a different risk level. U.S. Treasury bonds are considered the safest, but their yields are lower than more risky bonds, like corporates and municipals. Do you want a smoother ride or do you want the highest interest rates available? These are things to think about when building your portfolios.

If you have done your homework, you should be able to describe the nature and characteristics of each portfolio you have to your spouse, partner, best friend, or the members of your investment club. If you can't do this, then all you have is a random collection of financial assets. You will be at the mercy of the markets and your performance will be unpredictable.