Finding an Optimal Portfolio
If you decide to invest your hard-earned money, you naturally want to minimize your risks and maximize your potential returns. This is the basis of Modern Portfolio Theory (MPT). Developed by Nobel Laureate Harry Markowitz and refined by other noted economists over the years, MPT suggests that you can limit the volatility in your portfolio while improving its performance by spreading the risk among different types of securities that don't always behave the same way.
One principle of investing states that the higher the risk, the higher the potential return and conversely, the lower the risk, the lower the return. According to MPT, a portfolio (a combination of individual investments) exhibits risk and return characteristics based on its composition and the way those components correlate with each other. For each level of risk, there is an "optimal" asset allocation that is designed to produce the best balance of risk versus return. An optimal portfolio will provide neither the highest returns, nor the lowest risk of all possible portfolio combinations. It will attempt to balance the lowest risk for a given level of return and the greatest return for an acceptable level of risk. This meeting point of each level of risk and reward, where optimal portfolios reside, is called the "Efficient Frontier."