Mutual Fund Theorem


DEFINITION of 'Mutual Fund Theorem'

An investing theory, postulated by Nobel laureate James Tobin, that states that all investors should hold an identically comprised portfolio of "risky assets" combined with some percentage of risk-free assets or cash. A conservative investor would hold a higher percentage of cash, but would have the same basket of risky investments in his or her portfolio as an aggressive investor.


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BREAKING DOWN 'Mutual Fund Theorem'

The mutual fund theorem came about as a result of the mean-variance framework laid out by Harry Markowitz and his theories on how diversification limits portfolio risk. The viability of the mutual fund theorem has been questioned because several important assumptions must be in place for the theorem to be proved. These include a lack of transaction costs and perfectly transparent markets.

  1. Portfolio

    A grouping of financial assets such as stocks, bonds and cash ...
  2. Diversification

    A risk management technique that mixes a wide variety of investments ...
  3. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
  4. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
  5. Capital Asset Pricing Model - CAPM

    A model that describes the relationship between risk and expected ...
  6. Portfolio Management

    Portfolio Management is the art and science of making decisions ...
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