Efficient Frontier


DEFINITION of 'Efficient Frontier'

A set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal, because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are also sub-optimal, because they have a higher level of risk for the defined rate of return.


Loading the player...

BREAKING DOWN 'Efficient Frontier'

Since the efficient frontier is curved, rather than linear, a key finding of the concept was the benefit of diversification. Optimal portfolios that comprise the efficient frontier tend to have a higher degree of diversification than the sub-optimal ones, which are typically less diversified.

The efficient frontier concept was introduced by Harry Markowitz in 1952 and is a cornerstone of modern portfolio theory.

  1. Homogeneous Expectations

    An assumption in Markowitz Portfolio Theory that all investors ...
  2. International Beta

    Better known as "global beta", international beta is a measure ...
  3. Portfolio

    A grouping of financial assets such as stocks, bonds and cash ...
  4. Return

    The gain or loss of a security in a particular period. The return ...
  5. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
  6. Risk

    The chance that an investment's actual return will be different ...
Related Articles
  1. Bonds & Fixed Income

    Is Your Portfolio Beating Its Benchmark?

    Compare portfolio manager performance using the information ratio.
  2. Investing Basics

    Explaining The Efficient Frontier

    Most investment choices involve a tradeoff between risk and reward. The "Efficient Frontier" is a modern portfolio theory tool that shows investors the best possible return they can expect from ...
  3. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  4. Options & Futures

    Financial Concepts

    Diversification? Optimal portfolio theory? Read this tutorial and these and other financial concepts will be made clear.
  5. Investing

    In Search of the Rate-Proof Portfolio

    After October’s better-than-expected employment report, a December Federal Reserve (Fed) liftoff is looking more likely than it was earlier this fall.
  6. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  7. Investing

    What a Family Tradition Taught Me About Investing

    We share some lessons from friends and family on saving money and planning for retirement.
  8. Retirement

    Two Heads Are Better Than One With Your Finances

    We discuss the advantages of seeking professional help when it comes to managing our retirement account.
  9. Investing Basics

    Why Interest Rates Affect Everyone

    Learn why interest rates are one of the most important economic variables and how every individual and business is affected by rate changes.
  10. Investing

    Where the Price is Right for Dividends

    There are two broad schools of thought for equity income investing: The first pays the highest dividend yields and the second focuses on healthy yields.
  1. How have portfolios from within the efficient frontier performed historically?

    By definition, portfolios within the efficient frontier have historically performed well. Determining which portfolios operate ... Read Full Answer >>
  2. What are the advantages of portfolio planning with the efficient frontier?

    The advantages of portfolio planning with the efficient frontier are based in Harry Markowitz's modern portfolio theory (MPT), ... Read Full Answer >>
  3. How reliable is the mean variance analysis of an investment?

    Mean variance analysis of an individual investment or asset can provide a historical measure of volatility for the investment. ... Read Full Answer >>
  4. What level of correlation among investments will guarantee market returns but have ...

    The efficient frontier set forth by modern portfolio theory (MPT) can provide an estimate of an optimal portfolio that allows ... Read Full Answer >>
  5. How does covariance impact portfolio risk and return?

    Covariance provides diversification and reduces the overall volatility for a portfolio. Covariance is a statistical measure ... Read Full Answer >>
  6. How is correlation used in modern portfolio theory?

    Modern portfolio theory (MPT) emphasizes that investors can diversify away the risk of investment loss by reducing the correlation ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  2. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  3. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  4. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  5. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  6. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
Trading Center