Modern Portfolio Theory


Modern portfolio theory is an idea pioneered by Harry Markowitz arguing that an investment's risk and return characteristics are linked together by how the investment affects the overall portfolio's performance. It shows how risk-averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward.

In his own words, Harry Markowitz said, "the basic concepts of portfolio theory came to me one afternoon in the library while reading John Burr Williams's Theory of Investment Value. Williams proposed that the Value of a stock should equal the present Value of its future dividends. Since future dividends are uncertain, I interpreted Williams's proposal to be to Value a stock by its expected dividends. But if the investor were only interested in expected Values of securities, he or she would only be interested in the expected Value of the portfolio; and to maximize the expected Value of a portfolio one need invest only in a single security."