An overview of modern portfolio theory

Modern portfolio theory (MPT) is a theory of finance that attempts to maximize the expected return on a set of investments (known as the portfolio), relative to the overall risk of the combined items in the portfolio. The concept is that given a particular level of risk, the return will be maximized for that risk. This is common in retirement plans. The younger the investor and the smaller the amount in the portfolio, the more there is a willingness to take risks on higher returns. As the investor comes close to retirement and the total value of the portfolio is higher, the more likely they are to take lower risks, to ensure that the base of the portfolio is not lost but that at the tradeoff of potential gains being lower.

MPT provides a mathematical model of diversified investment with the goal of selecting a collection of investments that has a combined risk that is less than any individual asset in the portfolio. This is achievable by selecting individual...