Course 503: Modern Portfolio Theory
Applying Modern Portfolio Theory to Your Investment Reality
In this course
1 Introduction
2 Risk and Return
3 Diversification and an "Efficient" Portfolio
4 Applying Modern Portfolio Theory to Your Investment Reality

While the idea of an efficient portfolio and the efficient frontier graph make great theory, how can they be applied to your own investment situation? After all, few individual investors can create efficient frontier graphs for themselves, nor determine what their efficient portfolio would be. And even if investors had the time and technology to do so, market prices change, and the riskiness of asset classes isn't static.

What's important here isn't the details of the efficient frontier graph, nor finding the most efficient portfolio for you. Rather, the takeaways from Modern Portfolio Theory are:

1. Risk and return are directly linked. If you want a chance at greater returns, you’ll need to take on more risk.

2. Diversification across securities that do not behave alike reduces your portfolio's overall risk.

Those two concepts are so firmly ingrained among investors that you probably used them to build your portfolio, even if you’d never heard about Modern Portfolio Theory before today. For example, your asset allocation is the direct result of your time horizon, risk tolerance, and financial goal. To reach that goal in the appropriate amount of time, you must take on a certain level of risk.

Further, you're likely controlling risk in your portfolio by mixing investments that have a low correlation with one another. For example, the stock and bond markets don't usually move in the same direction. By having a portfolio that includes both stocks and bonds, you're one step closer to a more diversified and less risky portfolio.

Next: The Quiz >>

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