Definition: A portfolio is a collection of assets which are intended to grow overtime. The key considerations of any portfolio discussion are: 1) how diverse is the range of assets in your portfolio, 2) how much time are you allowing the portfolio to perform—a short horizon (yearly) or a long horizon (i.e. five to ten or even thirty-year time horizons?), and 3) will your portfolio be actively managed (i.e. full of discretionary re-allocations based on market data, fears, hunches or knowledge) or largely passively managed with a more “buy-and hold” or “set-it-and-forget-it” mentality/approach.
Modern Portfolio Theory: MPT is an approach to portfolio management which strongly maintains that portfolios do better in the long run by sticking to specific and time-tested diversification models and minimal active intervention by trying to time market changes.
Market Efficiency/The Efficient Market Theory: This theory maintains that markets are perfectly efficient and that whatever a stock or bond price is on a given day (or “random walk”), the said price is perfectly and fairly priced as an efficient reflection of its true value.
Risks: The major risks to portfolios are threefold: 1) concentration risk, 2) leverage risk and 3) timing risk.
Despite the efficient market theory, markets are not efficient and portfolio’s need to be more prepared for increased volatility ahead, particularly given the current macro-economic environment.
Further Reading: For more detail on portfolio construction and asset allocation, see “Asset Allocation and Portfolio Construction,” as well as “The Six Portfolio Secrets.”