APPROACHES TO CONSTRUCTION OF PORTFOLIO : There are two approaches to
constructing portfolio of securities: (a) Interior Decorating Approach (b) Markowitz
(a) Interior Decorating Approach : Interior decorating approach is tailor-made to the
investment objectives and constraints of each investor. In case of exterior building or
room structure, the furnishing and interior decoration to be carried out inside the
structure will depend upon the purpose for which it is to be used. Similarly, the
portfolio will consist of securities which will suit the individual’s investment objectives
and constraints. An individual investor has to carefully develop his portiolio-ovet a
period of years to suit his needs and match his investment objectives. A serious
minded investor will have to consider the following important categories of investment
(i) Protective investments : These investments protect the investors against the
uncertainties in life. The life insurance policy is a good example of this type of
(ii) Tax oriented investment : Some investments provide tax incentives to the
investors. For example, Public Provident Fund, National Savings Certificates etc.
(iii) Fixed income investments : These investment yield a fixed rate of return on
the investments. For example, investment in preference shares, debentures,
bank deposits etc.
(iv) Emotional investments : These investments are made for the purpose of
emotional security and satisfaction. Investors get some satisfaction from these
investments. For example, investment made in house property, jewellery,
household appliances etc.
(v) Speculative investments : These investments are made for the purpose of
speculation. The motive behind it is to make quick gains out of fluctuations in the
market. For example, investment in real estates, shares, commodity trading etc.
(vi) Growth investments : These investments are made for the purpose of earning
capital gains. These are not made for getting regular income. For example,
investment in growth shares, real estates, land, gold etc.
With the help of these variety of investments, we can attempt to develop a matrix for
matching the individual characteristics of specific investments so that a suitable
portfolio can be developed for each investor. In real life, building up a good portfolio
is a simple thing. A young family which may have a lot of insurance and considerable
growth portfolio should add some real estate by the time it reaches the midstream. At
the middle-age sets, the investors should avoid making risky and speculative
investments. They should make the necessary emotional investments which will
provide security and mental peace in the old age. When they are on the verge of
retirement and even during retirement their portfolio should preferably consist of safe
and income generating investments.
(b) Markowitz Approach : Markowitz approach provides a systematic search for optimal
portfolio. It enables the investors to locate minimum variance portfolios i.e. portfolios
with the least amount of risk for different levels of expected return. It is the process of
combining assets that are less than perfectly positively correlated in order to reduce
portfolio risk without sacrificing portfolio returns. It is more analytical than simple
diversification because it considers correlations between assets returns for lowering risk.
There are computer based packages available for determining the efficient portfolios. If
we go through this process for different levels of expected returns, we can locate
minimum variance portfolio. Application of the above package will tell us how much we
can invest in each security to form an efficient portfolio for a given level of return.
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