Modern Portfolio Theory

Modern Portfolio Theory attempts to manage and define portfolio risk. The theory focuses on the relationships of all assets in a portfolio and holds that risks can be lowered through selection of assets whose returns are not correlated.

The goal of Modern Portfolio Theory is to construct the most efficient portfolio from a set of assets. The most efficient portfolio gives the most return for a given amount of risk or the least risk for a given amount of return. The set of efficient portfolios constructed from a set of assets is called the efficient frontier.

Below is a graph of the efficient frontier for a mix of stocks (S&P 500) and bonds (10-yr US Treasuries) from 12/31/71 through 1/31/17. The efficient frontier is formed by sweeping the relative weighting of stocks with respect to bonds. An investor can choose his allocation based on where his risk/reward goals lie on the curve.

 

Disclosure:

The information presented here is the opinion of the author and may quickly become outdated and is subject to change without notice. All material presented in this article are compiled from sources believed to be reliable, however accuracy cannot be guaranteed. No person should make an investment decision in reliance on the information presented here.

The information presented here is distributed for education purposes only and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or participate in any particular trading strategy.

Performance data showing past performance results is no guarantee of future returns.

Performance data showing past performance results is no guarantee of future returns.

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