Control System Analogy of My Investment Portfolio

Having written a piece on Stock Market vs Control System last time at http://ghchua.blogspot.com/2008/11/stock-market-vs-control-system.html, I was tempted to write another piece on control system analogy. So here it is.......

A few people asked me - Since you viewed the stock market as a control system (most possibly a closed loop one), could you gave an analogy of your investment portfolio using Control Engineering concepts as well? My answer is yes, since Control Engineering concepts are applicable in physical systems, including one's investment portfolio.

I view my investment portfolio as an open loop control system, which means no feedback as compared to the stock market. If you view my portfolio as a system itself, then the input to the system would be stock market volatility and the output is portfolio volatility. By observing the output of my portfolio with respect to the input, I can do some adjustment to system by using compensation. Which is essentially what all control system strive to do - To make it stable by applying compensation.

So when my portfolio output is more volatile than the stock market, I added compensation to my system by introducing more value stocks into my portfolio. If it is less volatile than the stock market, then I may be tempted to add some growth stocks. Essentially, what I am trying to do is not to achieve a almost risk-free portfolio (i.e. low risk, high return), but rather making the system stable and not to oscillate into an unstable state which can cause chaos. I am taking risk by holding my portfolio throughout market cycles, but I am not taking high risk by doing consistent and regular investment back into the portfolio throughout any market condition.

Since Engineering is Applied Science, we are not looking at creating a perfect system (i.e. Making money in the stock market all the time). Rather, we strive to solve problems and make things work. There might be some imperfection here and there, but it is ok to me as long as it works most of the time.