What Is an Efficient Portfolio?
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What Is an Efficient Portfolio?
The Modern Portfolio Theory states that it is possible to balance risk and reward in order to make investments more efficient. An efficient (or optimal) portfolio consists of investments in a variety of asset classes selected for minimum correlation in order to lower portfolio volatility.
Things To Know
- It is possible to balance risk and reward efficiently.
- Efficient portfolios have the highest returns for the lowest possible volatility.
How asset classes relate
Examples of asset classes include cash, bonds, and stocks. Each asset class has differing degrees of volatility. The number of assets in a portfolio is not as important as the relationship among those assets. Modern Portfolio Theory looks at portfolios as a whole rather than focusing on the performance of individual securities.
Return and risk balanced
Efficient portfolios have the highest returns for the lowest possible volatility. To select an efficient portfolio, you choose one from the efficient frontier (the entire group of possible optimal portfolios) that matches your risk tolerance. You should keep in mind, however, that in general, the lower the volatility, the lower the potential return.
Modern Portfolio Theory assumes that investors dislike risk. They will make investment decisions based on maximizing their returns for an acceptable level of risk.