Mutual Fund Theorem

Loading the player...

What is the '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.

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.

RELATED TERMS
  1. Irrelevance Proposition Theorem

    A theory of corporate capital structure that posits that financial ...
  2. Bayes' Theorem

    A formula for determining conditional probability named after ...
  3. Coase Theorem

    A legal and economic theory that affirms that where there are ...
  4. James Tobin

    An American economist who won the Nobel Memorial Prize in Economics ...
  5. Capital Market Line - CML

    A line used in the capital asset pricing model to illustrate ...
  6. Harry Markowitz

    A Nobel Memorial Prize winning economist who devised the modern ...
Related Articles
  1. Investing

    Understanding the Modigliani-Miller Theorem

    The Modigliani-Miller (M&M) theorem is used in financial and economic studies to analyze the value of a firm, such as a business or a corporation.
  2. Markets

    Explaining the Central Limit Theorem

    Central limit theorem is a fundamental concept in probability theory.
  3. Managing Wealth

    Understanding Portfolio Investment

    Portfolio investment involves buying securities with the expectation of earning a return on them.
  4. 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.
  5. Managing Wealth

    Redefining Investor Risk

    Changing the way you think about time and risk can change the way you invest.
  6. Managing Wealth

    Introduction To Investment Diversification

    Reducing risk and increasing returns in your portfolio is all about finding the right balance.
  7. Retirement

    A Sanity-Saving Retirement Stock Portfolio

    The market rollercoaster has many retirees calling it quits on stocks. Big mistake.
  8. Trading

    Make Your Portfolio Safer With Risky Investments

    A high-risk security can reduce risk overall. Find out how it works.
  9. Managing Wealth

    In Praise Of Portfolio Simplicity

    Find out how you can streamline your investments for greater returns.
  10. Financial Advisor

    Mutual Funds: How Many is Too Many? (VTSMX, VBMFX)

    How many mutual funds are too many when it comes to a well diversified portfolio?
RELATED FAQS
  1. What are the main principles of the Heckscher-Ohlin Model?

    Learn about the four main principles of the Heckscher-Olin model, and find out how the model describes patterns of commerce ... Read Answer >>
  2. What is Fisher's separation theorem?

    Fisher's separation theorem stipulates that the goal of any firm is to increase its value to the fullest extent, regardless ... Read Answer >>
  3. How is portfolio variance reduced in Modern Portfolio Theory?

    Learn about modern portfolio theory, specifically what it asserts about asset allocation and managing portfolio risk through ... Read Answer >>
  4. How do I calculate the percentage gain or loss for my portfolio when all of the stocks ...

    Finding the total percentage gain or loss on a portfolio requires a few simple calculations. First, you should understand ... Read Answer >>
  5. Why is risk return tradeoff important in designing a portfolio?

    Learn how the risk return tradeoff is used in the construction of portfolios, and how modern portfolio theory seeks to diversify ... Read Answer >>
  6. Can mutual funds invest in hedge funds?

    Learn about mutual fund portfolio management techniques and mutual funds' ability to invest in hedge funds, as well as new ... Read Answer >>
Hot Definitions
  1. Quantitative Trading

    Trading strategies based on quantitative analysis which rely on mathematical computations and number crunching to identify ...
  2. Bond Ladder

    A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of ...
  3. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  4. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  5. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  6. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
Trading Center