Unlike the investment approach of classic security analysis that focuses on individual security selection, portfolio investment is a modern investment method that involves asset allocation and diversification to construct a collection of investments. The biggest challenge in investing is the uncertainty of an investment's future performance and thus the risk of potential investment losses. Not counting on investment results of single investments, portfolio investment can hedge investment risks by canceling out different investment returns among component investments.
Risk Diversification and Reduction
Portfolio investment is about reducing risk rather than increasing return. It may well be that in certain years, individual investment returns based on security analysis exceed returns from portfolio investment. However, over the long run, portfolio investment is able to deliver a steady rate of return that is on average better than individual investment returns, because of the risk diversification among various investments inside a portfolio. Portfolio investment seeks out different asset classes that are less correlated or negatively correlated, such as combining stocks and bonds to even out volatility.
Minimal Security Analysis
Traditional security selection requires considerable efforts in terms of time and resources to perform the so-called three-step analysis of economy, industry and company. Although portfolio investment involves assembling a collection of individual securities, the focus is less about the merits of each security standing alone but more about how they may fit with the expected overall performance of the portfolio. Some portfolio investment, once constructed, can be left unadjusted regardless of the changing economic environment. When investment results are not solely dependent on an expected above-average performance of an individual security, a simple security analysis technique like security screening can keep the work of security analysis at a minimum.
Systematic Investment Approach
As portfolio investment moves away from mere individual security selections, it employs a systematic investment approach that is supposed to benefit the owner of the investment portfolio in the long run. To achieve such a positive, long-term goal, a portfolio investment starts with setting portfolio objectives followed by formulating an investment strategy. The level of expected rate of return and risk tolerance are assessed so that different weights can be assigned to different asset classes and categories. The future performance of portfolio investment hinges on the overall investment policy that strives to ensure that losses from one security are compensated by gains from the other.
Passive Investment Style
Active investment management of constant buying and selling increases transaction costs and has tax implications that can be especially worrisome when a short-term holding period results in capital gains taxed as ordinary income. While individual security selections rely on active stock picking to influence performance, portfolio investment is designed to be passively managed, minimizing portfolio turnovers to necessary portfolio rebalancing. The set percentage of weights assigned to different assets and securities does not have to respond to every move of the market and even the economy, as long as the total risk profile of the portfolio remains unchanged.