Concept
The fundamental concept behind MPT is that the assets in an investment portfolio should not be selected individually, each on their own merits. Rather, it is important to consider how each asset changes in price relative to how every other asset in the portfolio changes in price.
Investing is a tradeoff between risk and expected return. In general, assets with higher expected returns are riskier. For a given amount of risk, MPT describes how to select a portfolio with the highest possible expected return. Or, for a given expected return, MPT explains how to select a portfolio with the lowest possible risk (the targeted expected return cannot be more than the highest-returning available security, of course, unless negative holdings of assets are possible.)
Therefore, MPT is a form of diversification. Under certain assumptions and for specific quantitative definitions of risk and return, MPT explains how to find the best possible diversification strategy.
Read more about this topic: Modern Portfolio Theory
Famous quotes containing the word concept:
“Every new concept first comes to the mind in a judgment.”
—Charles Sanders Peirce (1839–1914)
“One concept corrupts and confuses the others. I am not speaking of the Evil whose limited sphere is ethics; I am speaking of the infinite.”
—Jorge Luis Borges (1899–1986)
“The new concept of the child as equal and the new integration of children into adult life has helped bring about a gradual but certain erosion of these boundaries that once separated the world of children from the word of adults, boundaries that allowed adults to treat children differently than they treated other adults because they understood that children are different.”
—Marie Winn (20th century)