Modern portfolio theory: A powerful tool for futures investing Part 1 by Gary S. Antonacci
In an effort to improve on the traditional risk and return characteristics available from investment
opportunities, academic researchers developed Modern Portfolio Theory. Modern Portfolio Theory shifts
the focus of attention from individual investments to portfolios of investments. In fact, the basic premise
of Modern Portfolio Theory is that investors should only be concerned with the expected returns and
risks of their entire investment portfolio. Returns and risks on individual investments matter only in how
they effect overall portfolio returns and risks.
An important assumption of Modern Portfolio Theory is that all investors are risk-averse. In other words,
investors want high returns while limiting variability of returns. The theory shows how risk-averse
investors should combine individual investments in their portfolios to give the least risk possible,
consistent with the returns they seek. To quote Burton Malkiel in Random Walk Down Wall Street , "The
theory gives a rigorous mathematical justification to the age-old investment maxim that diversification is
a sensible strategy for investors wanting to reduce risk."