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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.

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