Hello Steemers, I would like to brief through the need of creating portfolio and why it is important to all set of investors in achieving their financial goals.
The money that a retail investor parks, is a contribution of his hard-earned savings and the individual has to bear lot of pain while see it depleting without constructive segmentation.
There are various challenges while opting an investment i.e, which asset class should I choose, what's the proportion that I have to contribute, do I take a portfolio approach or go heavy on single security which I feel is best in near future.
Let's review an example, which briefs how disastrous it could be if one doesn't understand portfolio approach:
The diversification concept which states, "never put all your eggs in one basket", can be explained with one of the true incident happened in 1990s, Enron Corporation, U.S. gave exponentially good returns (27% and more) from 1990 to 2000 while the benchmark S&P 500 yielded 13%.
Several employees of Enron participated in the 401(k) retirement plan, during which the employer had given the employees an option to deposit Enron shares with respect to their contributions; though the firm restricted the sale of shares until an employee turned 50 years though this contribution was just 11.5% of 62% from US$ 2 billion (62% of the investments were just in Enron shares, imagine the risk exposure) and who wouldn't have said no to it as the CAGR was fabulous with comparison to the index. The conclusion was the employees continued to hold large number of shares even though later they had the option to sell off and invest the proceeds in different assets.
Between 2001 and 2002 the stock price degraded from US$ 90 to 0. Several employees you had invested their life savings was in despair and huge financial ruin. This signifies how important it is to layer your investments rather being optimistic on certain instrument and levying larger weight-age of cash outflows
Hence Portfolio approach not only avoids potential disaster related to over investing in single security, but also provides equivalent expected returns with lower overall volatility of returns.
Please feel free to correct me, and your feedback is very important to me.
Note: I have refereed CFA curriculum in order to understand the concepts in short and refereed it to prepare this short summary.
