When I was in business school at the University of Michigan we spent a substantial amount of time studying Modern Portfolio Theory (MPT). MPT evolved from a paper written by Harry Markowitz in 1952 for the Journal of Finance called "Portfolio Selection".
The heart of the theory is that risk can be reduced and returns maximized by a selection of a variety of assets that move in different ways as factors such as economic growth, interest rates and the business cycle undergo change. The focus is more on interaction between the asset classes rather than the performance of any one asset.
MPT is the basis for most financial planning that is done these days. The theories that have evolved about diversification are used widely by pension funds, mutual funds and long term investors.
The question that is at the heart of all money management approaches is 'what is the best way to manage and reduce risk?' The main idea behind MPT is that risk is managed primarily through diversification into a variety of stocks and asset classes so that when one area is weak it is offset by strength in another area. Bonds and stocks are theoretically supposed to move in opposite directions so at various points in the economic cycle holding some of each will provide a higher level of safety. There are many studies and lots of complex math that prove that MPT is an effective way to manage money.
My view of portfolio management is different. I believe that the best way to manage risk isn't through holding diverse assets but to focus primarily on stocks and to manage risk by stock selection, disciplined methodology and vigilance. In other words, put your eggs in one basket and then watch that basket. If you simple want a market rate of return then buy an index fund but if you want superior returns this is the most likely way to do it.
The great benefit of the traditional portfolio management approach is that it is much more passive. There isn't the need to manage individual stocks as closely because you are relying on asset allocation to protect you. It is expected that certain asset classes are going to decline at various times but that isn't a big problem as long as the relationship between the asset classes is intact.
In my stock picking approach to portfolio management, it is paramount that you track your stocks every day and act swiftly and decisively as conditions change. You control risk by selling and holding cash until another good opportunity comes along.
Stock selection is one of the most enjoyable aspects of the investment business. There are few things more satisfying than finding a good idea and watching it work. It still requires a great amount of effort to find these ideas but if you are an astute stock picker it makes the job much easier.
The problem most people have with the stock picking approach to portfolio management is 'style drift'. Rather than focus on pure stock picking and a rigid methodology, they approach it like some sort of junior mutual fund. Time frames are unclear, stop levels uncertain, trades turn into investments, investments turn into trades and emotions drive the decision-making process. One day we want be a Warren Buffett and hold stocks for a very long term and the next day we are scalping 'pot' stocks for pennies.
Stock picking can produce superior returns over classic portfolio management but it is much more work. My theory has always been that highly aggressive trade management is ultimately the best way to protect your capital but it is not easy.
When someone asks you if you are picking stocks or running a portfolio, you can tell them you are doing both. They are not mutually exclusive and I contend that a disciplined stock picker will outperform a traditional portfolio and will have less risk.