Modern Portfolio Theory

Modern Portfolio Theory (MPT) is a framework for constructing optimal investment portfolios that balances risk and return. Introduced by Harry Markowitz in 1952, MPT suggests that investors can optimize their portfolios by diversifying their investments across various assets, as the risk of the portfolio is less than the weighted average risk of its components.

MPT matters because it revolutionized portfolio management by demonstrating that risk is not inherent to individual assets but can be reduced through diversification. For instance, an investor might allocate 60% to stocks and 40% to bonds, aiming to maximize expected return for a given level of risk, or to minimize risk for a given level of expected return.