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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    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  2. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  3. What are the risks of annuities in a recession?

    Annuities come in several forms, the two most common being fixed annuities and variable annuities. During a recession, variable ... Read Full Answer >>
  4. Do financial advisors get paid by mutual funds?

    Financial advisors are reimbursed by mutual funds in exchange for the investment and financial advice they provide. A financial ... Read Full Answer >>
  5. Why is fiduciary duty so important?

    Fiduciary duty is one the most important professional obligations. It basically provides a much-needed protection for individuals ... Read Full Answer >>
  6. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>

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