Investing 101

Lesson 3: New Investment Technology

Modern Portfolio Theory

The premise behind Modern Portfolio Theory (MPT) is that all investors are risk-averse. They want high returns and guaranteed outcomes. This theory tries to help investors take the least risk to get the best returns. Diversification is the key to risk reduction using this theory.

Economist Harry Markowitz invented this theory in the 1950s and in 1990 won the Nobel Prize in Economics for his work. He proves that diversification creates less risk with extensive mathematical modeling. Basically, the theory explains how portfolios of risky or volatile stocks can be put together in a larger portfolio, which will ultimately be less risky than individual stocks. To truly diversify your portfolio, you must build it with stocks that are not all dependent on the same economic variables.

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