Reason for Stock Portfolio
A reason for the treatment of portfolio management as a separate article is that it depends upon the needs and tastes of individual investors. It is possible to estimate expected returns for individual securities without regard to any investor, but it is impossible to construct a portfolio which is optimum for an individual investor without taking his needs and tastes into account. The output of security analysts is essential for portfolio management, or at least portfolio managers make use of the output of security analysts, but this output must be analyzed with reference to the tastes and financial circumstances of individual investors in the construction of portfolios. Although security analysis can be impersonal, portfolio management cannot.
The next section of this article discusses Markowitz's portfolio theory, the basis of all scientific portfolio management. The following section discusses the subject of the optimality of a portfolio for the individual investor.
The portfolio theory developed by Markowitz can be summarized as follows: (1) the two relevant characteristics of a portfolio are its expected return and its riskiness; (2) rational investors will choose to hold efficient portfolios which are those which maximize expected returns for a given degree of risk or, alternatively and equivalently, minimize risk for a given expected return; (3) it is theoretically possible to identify efficient portfolios by the proper analysis of information for each security on its expected return, the variation or variance in that return, and the relationships between the return for each security and that for every other security; and (4) there is a specified, manageable computer program which utilizes inputs from security analysts in the form of the three kinds of necessary information about each security in order to specify a set of efficient portfolios. The program indicates the proportion of an investor's fund which should be allocated to each security in order to achieve efficiency, i.e., the maximization of return for a given degree of risk or the minimization of risk for a given expected return.
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