Financial Concepts: The Optimal Portfolio
AAA
  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion
Financial Concepts: The Optimal Portfolio

Financial Concepts: The Optimal Portfolio


The optimal portfolio concept falls under the modern portfolio theory. The theory assumes (among other things) that investors fanatically try to minimize risk while striving for the highest return possible. The theory states that investors will act rationally, always making decisions aimed at maximizing their return for their acceptable level of risk.

The optimal portfolio was used in 1952 by Harry Markowitz, and it shows us that it is possible for different portfolios to have varying levels of risk and return. Each investor must decide how much risk they can handle and than allocate (or diversify) their portfolio according to this decision.

The chart below illustrates how the optimal portfolio works. The optimal-risk portfolio is usually determined to be somewhere in the middle of the curve because as you go higher up the curve, you take on proportionately more risk for a lower incremental return. On the other end, low risk/low return portfolios are pointless because you can achieve a similar return by investing in risk-free assets, like government securities.


You can choose how much volatility you are willing to bear in your portfolio by picking any other point that falls on the efficient frontier. This will give you the maximum return for the amount of risk you wish to accept. Optimizing your portfolio is not something you can calculate in your head. There are computer programs that are dedicated to determining optimal portfolios by estimating hundreds (and sometimes thousands) of different expected returns for each given amount of risk. Financial Concepts: Capital Asset Pricing Model (CAPM)

  1. Financial Concepts: Introduction
  2. Financial Concepts: The Risk/Return Tradeoff
  3. Financial Concepts: Diversification
  4. Financial Concepts: Dollar Cost Averaging
  5. Financial Concepts: Asset Allocation
  6. Financial Concepts: Random Walk Theory
  7. Financial Concepts: Efficient Market Hypothesis
  8. Financial Concepts: The Optimal Portfolio
  9. Financial Concepts: Capital Asset Pricing Model (CAPM)
  10. Financial Concepts: Conclusion
Financial Concepts: The Optimal Portfolio
RELATED TERMS
  1. Current Liquidity

    The total amount of cash and unaffiliated holdings compared to ...
  2. Developed To Net Premiums Earned

    The ratio of developed premiums to net premiums earned over a ...
  3. Return On Policyholder Surplus

    The ratio of an insurance company’s net income to its policyholder ...
  4. Discretionary Investment Management

    A form of investment management in which buy and sell decisions ...
  5. Account Minimum

    The minimum balance required to be maintained in an investment ...
  6. Capital Growth

    The increase in value of an asset or investment over time. It ...
  1. How do you calculate retained earnings per share?

    Research the amount of retained earnings per share compared over time to understand whether or not a company uses its profits ...
  2. What is the minimum amount of money that I can invest in a mutual fund?

    Learn about investing in mutual funds even with a smaller initial investment; there are many funds available to investors ...
  3. How do I sign up for a TreasuryDirect account?

    Invest in Treasury securities by dealing directly with the U.S. Department of the Treasury online, conveniently managing ...
  4. How can I get a mutual fund prospectus?

    Read and understand the prospectus before investing in a mutual fund. You can obtain a copy from the fund company, your financial ...
Related Tutorials
  1. Ethical Investing Tutorial
    Fundamental Analysis

    Ethical Investing Tutorial

  2. Investing For Safety and Income Tutorial
    Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  3. American Depositary Receipt Basics
    Economics

    American Depositary Receipt Basics

  4. Macroeconomics
    Economics

    Macroeconomics

  5. Capital Budgeting
    Investing Basics

    Capital Budgeting

Trading Center