Portfolio

Definition

A portfolio is a specific weighting of assets.

Notation

Portfolio weight is often represented by greek letter \omega (omega).

Why Do We Need Portfolios

Diversification is protection against ignorance. It makes little sense if you know what you are doing. – Warren Buffett

The primary purpose of a portfolio is to reduce risk through diversification.

If you know with certainty that stock A is going to provide the highest return in the future, you can simply buy A. (This is technically also a portfolio with 100% weight on A and 0% weight on everything else.) But if you know two stock A and B are going to provide the highest and second highest return, but not which is which, then the best way to invest is to split your money between A and B. This is diversification.

In real life, if you can pick stocks like Warren Buffett, you can have a highly concentrated portfolio and no need to diversify. But it is extremely difficult to constantly pick good stocks.

What Makes A “Good” Portfolio

This is where different theories come in. We need to know what investors want and what they want to avoid.

One of the most influential theories is the modern portfolio theory (MPT).

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