Constraints in Portfolio Revision ⛓️🚧
In a perfect textbook world, you would revise your portfolio every second to stay on the Efficient Frontier. In the real world, several "Constraints" act like friction, slowing you down or making revision impossible.
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1. Transaction Costs
Every time you sell or buy a security, you pay:
- Brokerage Fees: Charges by the broker for executing the trade.
- Market Impact: For large investors, selling a huge block of shares can actually drive the price down, resulting in a worse execution price.
2. Taxes (The Silent Performance Killer)
In many countries (like India), selling a stock for a profit triggers Capital Gains Tax.
- Short-Term (STCG): Usually a higher tax rate if you sell within a year.
- Long-Term (LTCG): Usually a lower tax rate if you hold longer.
Important
Sometimes, it is mathematically better to keep a "sub-optimal" stock rather than selling it and paying 15-20% of your gains to the government in taxes.
3. Liquidity Issues
Revision assumes you can sell a stock whenever you want.
- Reality: Some stocks (Small-cap or Penny stocks) have very few buyers. If you try to sell a large amount, you might not find a buyer, or you might have to accept a much lower price.
4. Statutory & Psychological Constraints
- Statutory: Mutual funds often have legal limits (e.g., they cannot put more than 10% in a single company).
- Psychological: Investors often suffer from Loss Aversion—they refuse to sell a "bad" stock because they don't want to admit they made a mistake and "realize" the loss.
Summary
- Revision is not free. It costs time, money, and taxes.
- Transaction Costs and Taxes are the two biggest constraints for individual investors.
- Liquidity can make revision difficult for large portfolios.
- Successful managers only revise when the Benefit > Total Cost.
Quiz Time! 🎯
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