Portfolio investments vs direct investments: characteristics, benefits and limitations

The modern sphere of finance offers a variety of tools for receiving passive income. Portfolio investments are one of the most popular methods of increasing capital through interest or dividends, which the investor receives from the funds invested in a company or project. Is it that simple and profitable or are there hidden risks? Is it worth trying on the role of a portfolio investor or is it better to stop at direct investments as a source of passive income?

What is portfolio investments

Portfolio investments vs direct investments: characteristics, benefits and limitations review

What does the term "portfolio investments"mean?

Portfolio investments are understood as "infusion" of funds into securities, i.e. into a so-called securities portfolio. In other words, a portfolio investor buys and holds financial assets (securities of different issuers) for a long period of time to obtain a passive income (interest, dividends).   

At the same time, the investor himself does not participate in direct management of the organization, project, etc., in which he invests.

Who can be a portfolio investor 

While there are restrictions on a number of investment instruments, everyone, without exception, may engage in portfolio investments.

For example:

  • an individual; 
  • a financial institution (bank); 
  • any investment fund.

Types of the most popular assets for portfolio investments

  • bonds;
  • shares of companies;
  • funds (real estate, stock, mutual funds (unit investment fund).
Portfolio investments vs direct investments: characteristics, benefits and limitations news

The advantages of Portfolio Investments

  • Financial freedom

This tool of passive income does not need a big starting capital. It is possible to begin to be engaged in portfolio investments with any budget.  

  • Flexibility of deeds

The investor can maneuver, defining an admissible border of risks and ways of reception, volumes of the prospective profitableness. 

  • The source of passive income

The investor doesn't need to develop the company or the project directly. It is an opportunity to be engaged in anything or not to work at all, "collecting the cream" due to profitable investments.

How does the portfolio investing work 

The procedure for forming an investment portfolio

An investment portfolio is a list of all securities that belong to the investor and are designed for long-term holding with the purpose of receiving passive income. 

Classification of investment portfolios

3 types of investment portfolios are distributed according to the level of profitability and the degree of financial risk. Namely:

  1. aggressive.

This type of investment portfolio is:

  1. High level of profitability.

At the expense of underestimated stocks and securities of the companies of the third echelon, i.e. the market outsiders - the companies with the lowered liquidity, the minimum volumes of trades or those who are newcomers in the stock market.

  1. High-risk. 

It is possible to reduce risks (and in parallel, income) with the help of "Blue Chip", i.e. companies that are dominant in a certain sector due to a large market share and brand popularity (Lukoil, VTB Bank, Coca-Cola Co, Apple Inc. etc.).

  1. Moderate. 

This type of investment portfolio assumes medium-risk conditions and medium level of return. As a rule, these are bonds, precious metals, which are the provision of a higher degree of reliability and safety of investment strategy.  

Some investment portfolios are characterized by absence of company stocks and projects, i.e. they may consist exclusively of

  1. precious metals;
  2. state securities.
  3. conservative. 

This type of investment portfolio is low-risk and has low profitability. Such an investment strategy is considered to be the safest one.

As a part of conservative investment portfolio:

  1. government bonds;
  2. stocks of state corporations;
  3. securities of large companies. 

How to determine the success and reliability of an investment portfolio 

An investment portfolio is generally considered to be such if it has the following properties as: 

  1. Liquidity. 

Securities are in high demand in the market, i.e., they can always be sold at a profit to buy, for example, even more profitable assets.

  1. Conservatism

I.e. assets belong to the least risky type of investment. Have the raised level of reliability thanks to application of the checked up tools and can provide a worthy level of profitability at the expense of securities of progressive, developing companies. 

  1. Diversification. 

This attribute is characteristic of portfolios, which include a large assortment of assets. When an investor insures and invests in projects/companies from different spheres and areas of business, this allows to significantly reduce risks, providing the highest level of capital security.

The role of a portfolio investor

For those who intend to try on the role of a portfolio investor, i.e. to invest in portfolio investments, there are a few basic steps to follow:

  1. Select the optimal timing for investing. 

Experienced investors recommend adhering to a time frame of 12 to 36 months to maximize your return.  Generally, portfolio investments are a long-term tool.

  1. Determine the amount of investment. 
  2. Choose a broker. 

There are 2 ways to manage portfolio investments.

  1. Independent.
  2. Confidential.

Transfer of sums for management by professional traders. It can be an individual broker or a company, which will form a portfolio and monitor its efficiency. When choosing a trustee, it is important to remember about the thorough documentary and rating check of the candidate (existence of a license to operate, reviews, etc.). Also, you should not forget about the commission, the choice of cooperation tariff plan, which is made taking into account the terms of investment. 

  1. Decide which strategy will be optimal.

When a brokerage account is opened, the time of forming, i.e. filling an investment portfolio (selecting and purchasing securities) is suitable, taking into account the three investment options mentioned above. 

  1. The most reliable ones are bonds, securities of state corporations.
  2. The medium-risk instrument - "blue chips", shares of companies with large capital.
  3. The most risky, however, and the most profitable - securities of startups, new promising companies. 
  4. Check the portfolio on a regular basis (for example, quarterly). Make adjustments as needed. 

It is a mistake to make weekly changes in the composition of the portfolio, unless there is a serious reason for it (for example, the bankruptcy of the issuer).      

  1. Use different types of instruments to diversify risks. 

Foreign portfolio investments

It is also possible to earn passive income from foreign portfolio investments. 

These are the same investments in government securities or stocks of companies for the sake of earning income. The only difference is that the investor is a citizen/company of another country.

What is direct investment

Direct investment is a financial contribution to material production/sales. This investment instrument implies not only receiving income from the contribution to the development of the project, but also control over business operations and direct participation of the investor in the management of the enterprise or company.

Direct investment implies a significant proportion of the purchase of shares of the company (up to full, 100% control by the investor).  

Direct and portfolio investment instruments: the differences

  • Involvement in management 

Direct investment instrument:

The investor receives the right to participate in the management of the business (determining key areas of development) and control after the purchase of a large volume of shares (over 10% of the total volume). 

Portfolio investment:

Investor acts as an "outside observer" with no right to intervene in the management/control of the business.

  • Capital returns

Direct investment:

The return on investment is higher. These are:

  • dividends;
  • interest from the rise in the price of securities;
  • a share of the company's profits.

Portfolio investments:

The profits from a contribution are lower. These are:

  • dividends from stocks/drags;
  • interest on bonds.
  • Timing 

Direct investments:

Investments are:

  • medium-term;
  • long-term (more than 5 years).

Portfolio investments.

The payback period of the investment is 12-36 months.

  • Purpose of funds from investor's contribution

Direct investments:

  • Formation of the basic fund of the enterprise;
  • distributed on modernization of key business processes.

Portfolio investments:

Funds may be allocated for any purpose. 

  • Openness to incomes.

Direct investments:

Direct investment instruments may be used exclusively by:

  • large investors;
  • funds. 

It is the right of the company to refuse an investor to buy a share of the company.

Portfolio investments

Any citizen or company may use this investment instrument. 

Let's summarize

Portfolio investments are the main or additional source of passive income for the investor. The income is received, as a rule, during a short- or medium-term period. Return on investment and profit depend on chosen investment strategy, terms and size of initial capital. Assets are usually purchased with the goal of selling them later to lock in a profit.

If you choose direct investments, you should expect a long payback period. Profits and timing depend, among other things, on the investor: how effectively he will develop and expand the business. 

Both investment tools can become reliable sources of profit. The main thing is to choose a reliable company to make a deposit, carefully check information, avoid common mistakes, and diversify risks.

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