Contents
Meaning of Portfolio Optimization
Portfolio optimization is the process of testing the feasibility, the net return, and profitability of given portfolios to choose the best among them. There are a lot of portfolios available on the market with different return factors. Some portfolios yield higher returns, but the risk in them is also very high. On the other hand, some portfolios yield very low returns while including a high degree of risk. And some are neutral; their return and risk are both low. So, to choose the best portfolio among the available options, the investor opts for portfolio optimization. Although portfolio optimization does not accurately predict how beneficial a portfolio is, it is still very advantageous.
Advantages of Portfolio Optimization
Maximizes the return
The first and most crucial advantage of portfolio optimization is that it maximizes the return for a given level of risk. The various tools used to calculate the feasibility of a portfolio enable investors to calculate the risk and return of a portfolio. This enables them to achieve a higher return by taking higher risks.
Diversification
Diversification is very important, as it helps investors protect themselves against the downside in case an asset doesn’t perform well. Optimal portfolios enable the option of diversification in cases of unsystematic or non-priced risk. This is because when an asset becomes worthless due to some reason, diversification in assets prevents the other valuable assets of the investor from crashing too. Thus providing the investor with a safer side.
Aids in planning
Portfolio management works as a step-by-step planning guide. It provides clarity in investment, helps in deciding the best asset from the available ones, lays down a blueprint for balanced control between risk and return, and helps in generating new ideas for new portfolios. Apart from this, it helps in identifying justified and high-yielding portfolios.
Helps in identifying market opportunities
When investors indulge in portfolio management regularly, they collect and store a lot of valuable data from the market. This data further helps them to track the opportunities prevailing in the market as well as the opportunities that are likely to arise shortly. By capturing these opportunities, they can make a first move and earn a lot of benefits.
Optimum utilization of resources
Portfolio optimization aids in making the best use of available resources. It helps in measuring the ways to reduce the costs, elaborating ways to minimize the risk, and suggesting ways to maximize the return.
Reduces human error
While selecting a portfolio, humans make several mistakes, such as: investing in stocks that appear to be strong but whose values go down in the future, selecting an asset that seems to generate high income but becomes faulty after a particular period, etc. By using portfolio optimization when selecting the best asset, portfolio, or other investment that balances risk and yields a higher return, mistakes are minimized and the scope for efficiency is increased.