Inputs for Investment Portfolio Construction

Investment portfolio is a composition of investments with the purpose, of maximizing return and minimizing risk. What individual investments would constitute the composition depends, in the first place, on the goals of the investment portfolio. One of the goal of the investment portfolio is return maximization. To achieve this, a choice of individual investment securities for inclusion in the portfolio is made and the return and risk of such individual investment securities are relevant inputs for investment portfolio construction. Thus, portfolio goal and return and risk of individual securities included in the portfolio are the inputs for investment portfolio construction.

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Investment Portfolio Goals

As investors differ like cornflakes, their portfolio goals also differ. One investor might prefer a portfolio that gives him maximum tax savings. So, this portfolio would consist of investments that have some tax leverage tagged on them. Housing, Govt. Securities, etc constitute his portfolio. Another investor wants a low, but nonfluctuating return. His portfolio would consist of scrips with stable and unbroken dividend policy and fixed yield giving bonds and the like. Another investor might want a portfolio that ensure a higher capital appreciation. So, scrips of growth sector/companies would predominantly form the portfolio. Another investor might want a sectoral portfolio, say banking sector portfolio or infrastructure sector portfolio. So his portfolio would consist of share of banking companies or infrastructure companies. An overseas investor in India might want a portfolio replicating BSE SENSEX or CNX Fifty. So, the specific 30 scrips, 50 scrips would form the investment portfolio. So, portfolio goals are the first and foremost input to initiate portfolio construction process. Current return, capital gain, tax benefit, liquidity, risk reduction, opportunity for participation in future capital expansion on a preferential basis, buy-back guarantee etc., are certain portfolio goals.

Return and Risk of Individual Securities

Portfolio management needs data as to return and risk of individual securities that the portfolio consists of. Because, portfolio return and portfolio risk (essential variables in portfolio management are derived from returns and risk of individual securities. Return means income of gain. Current income, capital gain, tax shield, right to subscribe to future issues, preferential allotment in future issues, etc. are all returns. The tax shield, right and preferential allotment, etc. generally get reflected in the price of the security and that capital gain is inclusive of all these. So, current income and capital gain are the principal types of returns of a security.

Read More: Risk and Return in Portfolio investments

In the case of shares, debentures, bonds, etc. which are referred to financial assets/investments, the future returns, their size and variability, are important factors influencing investment decisions. Measurement of return is an important task. Table shows below gives some common measures of return for individual equity and debt securities.


Current yield or estimated yield

Actual yield or realized yield

Debentures or bondsExpected interest / Current price of debenture or bondInterest received / Actual price of purchase
Shares or stocksExpected dividend / Current price of shareDividend received / Actual purchase price.

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