Modern portfolio theory
What is modern portfolio theory?
MPT, also known as portfolio management theory, is an influential economic concept according to which risk-averse investors can build portfolios to maximise expected return based on a given level of market risk, as risk is an innate part of higher reward.
Where have you heard about modern portfolio theory?
The theory was put forward by Harry Markowitz in his paper 'Portfolio Selection', published by the Journal of Finance in 1952. Nearly 60 years later he set out his latest thoughts on the matter here.
What you need to know about modern portfolio theory...
According to MPT, it's not enough to consider the expected risk and return of one particular stock. By investing in a portfolio of stocks, investors can reap the advantages of diversification. In other words, investment is not just about picking stocks - it's about selecting the right combination of stocks.
Five statistical risk measurements are used in MPT: alpha, beta, standard deviation, R-squared and the Sharpe ratio. These indicators are all designed to help investors establish the risk-reward profile of a mooted investment.
Find out more about modern portfolio theory...
Our guide to portfolio management has more on how to manage your share portfolio effectively.