Strategic Financial Management · Portfolio Theory and Practice

Portfolio Management Process, Active vs Passive Strategies and Revision

Updated 11 October 2026 · Fact-checked

Portfolio management is the ongoing process of building and maintaining a portfolio to meet an investor's goals. Its phases are security analysis, portfolio analysis, selection, revision and evaluation. To solve revision questions, identify the formula plan, fix the target, compute current values, then calculate the exact rupee amount to buy or sell.

Understand Portfolio Management Process and Revision

Portfolio management means choosing investments, combining them, and then looking after them so that they keep matching what the investor wants. It is not a one-time purchase. Markets move, and so do the investor's needs, so the portfolio needs regular attention.

The process runs in phases:

Security analysis: study individual securities and estimate their risk and return.
Portfolio analysis: build possible combinations of securities and study their risk and return.
Portfolio selection: pick the best combination for the investor's objectives and risk appetite.
Portfolio revision: change the holdings as prices and conditions change.
Portfolio evaluation: measure performance against a benchmark, adjusted for risk.

Some texts add a first step of setting objectives and constraints (return needed, risk tolerance, time horizon, tax, liquidity). Mention it in your answer if the question asks for the full process.

In an active strategy, the manager tries to beat the market. He uses forecasts, security selection and market timing. This costs more in research and trading, and it only pays if the manager's skill outweighs those costs. In a passive strategy, the manager does not try to beat the market. He holds a diversified portfolio, often one that copies an index, and trades rarely. This rests on the belief that markets are fairly efficient.

Portfolio revision is the act of selling some securities and buying others as conditions change. A formula plan is a set of mechanical rules for revision. You decide in advance when to act and by how much. This removes emotion: you sell when prices rise and buy when they fall. Formula plans split funds into an aggressive part (usually equity) and a conservative part (bonds or cash). The three standard plans are the constant rupee value plan, the constant ratio plan and the variable ratio plan.

Rebalancing means bringing the portfolio back to its target mix. The constant ratio plan is the most common example. Formula plans work best in markets that fluctuate. In a market that keeps rising, they sell early and the investor gains less. In a market that keeps falling, a constant rupee value plan keeps buying equity as it falls.

Key rules to remember

Constant rupee value plan: Equity held = a fixed rupee amount. Action = Fixed amount − Current equity value; If equity value is above the fixed amount, sell the excess and move it to bonds. If it is below, buy the shortfall from the conservative part.
Constant ratio plan: Target equity = Total portfolio value × equity ratio. Action = Target equity − Current equity value; A positive result means buy equity; a negative result means sell. Act only when the ratio moves beyond the pre-set revision limit, if the question gives one.
Variable ratio plan: Equity proportion falls as prices rise and rises as prices fall, as per a pre-set schedule; Use the ratio the question gives for the current price level. Apply it to total portfolio value, as in the constant ratio plan.
Total portfolio value: Total value = Equity value + Bond (or cash) value; Recompute it after every price change, before calculating the target.

How to solve Portfolio Management Process and Revision questions

Use this method for any question on the portfolio management process or on formula plans.

1Read the question and decide whether it asks for theory (phases, active vs passive) or for a calculation (formula plan).
2For theory, list the phases in order and give one line on each. Add a short note on how the manager's role differs under an active and a passive strategy.
3For a calculation, name the plan: constant rupee value, constant ratio or variable ratio.
4Write the starting position: equity value, bond value and total value.
5Update the equity value for the price change. Keep the bond value unchanged unless the question says otherwise. Find the new total.
6Find the target equity value under the plan. For a fixed rupee plan it is the fixed amount. For a ratio plan it is total value × the ratio.
7Subtract current equity from target equity. A positive result means buy and a negative result means sell. Show the new equity and bond values.
8Check that equity plus bonds equals the total, and state the action in plain words.

Quickest way: Three-line revision table

When to use it: Use it for any numerical question on formula plans when time is short.

Draw three columns: Equity, Bonds, Total. Fill the starting row.
After the price change, update equity and the total. Write the target equity beside it.
Difference = target − current. Sell or buy that amount, then write the new row and check that the total is unchanged by the trade.

Common mistakes in Portfolio Management Process and Revision

Applying the constant ratio to the old total instead of the new total.
Students forget that the total changes after the price move.
Fix: Always add the new equity value and the bond value first. Then multiply that new total by the ratio.
Mixing up the constant rupee value plan and the constant ratio plan.
Both sell on a rise and buy on a fall, so they look alike.
Fix: In constant rupee value the equity amount is fixed in rupees. In constant ratio the equity share of the total is fixed.
Describing the variable ratio plan as keeping the ratio fixed.
The name sounds like the constant ratio plan.
Fix: Remember that the equity proportion is deliberately reduced when prices rise and increased when prices fall, as per a pre-set schedule.
Treating portfolio revision as the last phase of the process.
Students list the phases from memory in the wrong order.
Fix: Write the order: security analysis, portfolio analysis, selection, revision, evaluation. Evaluation comes last and feeds back into revision.
Saying passive management means doing nothing.
Passive is read as careless.
Fix: Say that a passive manager holds a diversified portfolio, often matching an index, and trades rarely. This is a deliberate choice based on market efficiency.
Ignoring the revision limit given in the question.
Students rebalance after every price change.
Fix: If the question says to revise only when the ratio moves beyond a set limit, first check whether that limit is crossed. If it is not, no trade is needed.

Worked examples

Example 1

Rohit holds ₹5,00,000 in equity shares and ₹5,00,000 in bonds under a constant ratio plan of 50:50. Equity prices rise by 20%, and then the new equity value falls by 20%. Bond value stays unchanged. Show the revision after each move.

Show the solution

Start: equity ₹5,00,000, bonds ₹5,00,000, total ₹10,00,000.
After the 20% rise: equity = 5,00,000 × 1.20 = ₹6,00,000. Total = 6,00,000 + 5,00,000 = ₹11,00,000.
Target equity = 50% of 11,00,000 = ₹5,50,000. Current equity is ₹6,00,000, so sell ₹50,000 of equity.
After revision: equity ₹5,50,000, bonds 5,00,000 + 50,000 = ₹5,50,000. Total ₹11,00,000.
After the 20% fall: equity = 5,50,000 × 0.80 = ₹4,40,000. Total = 4,40,000 + 5,50,000 = ₹9,90,000.
Target equity = 50% of 9,90,000 = ₹4,95,000. Current equity is ₹4,40,000, so buy ₹55,000 of equity.
After revision: equity ₹4,95,000, bonds 5,50,000 − 55,000 = ₹4,95,000. Total ₹9,90,000.

Answer: After the rise, sell equity worth ₹50,000 and buy bonds. After the fall, sell bonds worth ₹55,000 and buy equity. The portfolio is back to 50:50 each time.

Example 2

Meena follows a constant rupee value plan. The equity part is fixed at ₹4,00,000 and the bond part starts at ₹4,00,000. Equity prices first rise by 25% and then, after revision, fall by 10%. Show the transactions and the final portfolio.

Show the solution

Start: equity ₹4,00,000, bonds ₹4,00,000, total ₹8,00,000.
After the 25% rise: equity = 4,00,000 × 1.25 = ₹5,00,000. The fixed amount is ₹4,00,000, so sell ₹1,00,000 of equity.
After revision: equity ₹4,00,000, bonds 4,00,000 + 1,00,000 = ₹5,00,000. Total ₹9,00,000.
After the 10% fall: equity = 4,00,000 × 0.90 = ₹3,60,000. The shortfall is 4,00,000 − 3,60,000 = ₹40,000, so buy ₹40,000 of equity from the bond part.
After revision: equity ₹4,00,000, bonds 5,00,000 − 40,000 = ₹4,60,000.
Check: total = 4,00,000 + 4,60,000 = ₹8,60,000. This equals 9,00,000 less the ₹40,000 fall in equity value.

Answer: Sell equity worth ₹1,00,000 after the rise. Buy equity worth ₹40,000 after the fall. The final portfolio is equity ₹4,00,000 and bonds ₹4,60,000, a total of ₹8,60,000.

Exam tips

Learn the phases of portfolio management in the right order, with one line each. This is a common short-answer question.
For active vs passive, write two or three points under each heading: aim, cost, and link to market efficiency.
In formula plan sums, draw the Equity, Bonds and Total table. Marks go for the steps and the buy or sell amount.
State the plan clearly and say whether the action is a sale or a purchase. A figure without a direction loses marks.
Read the question for a revision limit or trigger. If the question gives one, apply it before trading.

Practice questions from Portfolio Theory and Practice

Portfolio Management Process and Revision in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Portfolio Management Process and Revision: frequently asked questions

What are the steps in the portfolio management process?

The usual phases are security analysis, portfolio analysis, portfolio selection, portfolio revision and portfolio evaluation. Many answers begin with setting the investor's objectives and constraints. Evaluation feeds back into revision.

What is the difference between active and passive portfolio management?

An active manager tries to beat the market by security selection and timing, which costs more. A passive manager holds a diversified portfolio, often copying an index, and trades rarely. The passive approach rests on the idea that markets are fairly efficient.

How is the constant ratio plan different from the constant rupee value plan?

In the constant ratio plan, the share of equity in the total portfolio is kept fixed, say 50%. In the constant rupee value plan, the rupee value of the equity is kept fixed. Both sell equity when prices rise and buy when prices fall.

What is the variable ratio plan?

It is a formula plan in which the equity share changes with the price level. As prices rise, the share of equity is reduced by a set schedule. As prices fall, it is increased.