Investing Classroom: Modern Portfolio Theory

Portfolio lesson 5.3: MPT tries to make the most of the trade-off between risk and reward

Morningstar 16 March, 2010 | 12:51PM

Nothing ventured, nothing gained. You can't have your cake and eat it, too. Life is a series of trade-offs.

We're all familiar with these mottos, which remind us that to get something, we have to give something up. Investing requires sacrifices, too. We have to give up safety and take on risk to achieve better returns. Modern Portfolio Theory (MPT) tries to make the most of the trade-off, illustrating how to generate as much return as possible for the least amount of risk.

This lesson will examine the relationship between an investment's risk and its return, how diversification allows you to achieve the maximum amount of return for the least amount of risk, and the role MPT can play in your portfolio.

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