Efficient Frontier

The efficient frontier describes the relationship between the return that can be expected from a portfolio and its risk. It is a concept in modern portfolio theory introduced by Harry Markowitz and has stood the test of time.

To earn returns that beat inflation will involve a degree of risk with your capital. As an investor, understanding how much risk you are prepared to accept to achieve the returns you want is crucial.  

Whilst stock markets are going through a volatile phase at the moment, stock market returns over the long term have provided an upward trend. However, diversification makes sense for the serious investor looking to optimise returns.

Diversification involves spreading your investments across a range of asset classes – equities certainly, but also property, fixed interest and cash.

Diversifying your portfolio can help to reduce risk and increase your potential for good returns due to correlation. This means different asset classes often behave differently under the same economic conditions. So by investing in several types of asset, it is more than likely some will perform well even if the rest are temporarily declining.  

This is where the concept of the efficient frontier comes in, with its concept of the ‘optimal’ portfolio. The optimal portfolio works in two ways. Firstly, for any level of volatility, you review all the portfolios that have that degree of volatility. From that universe, select the one that has the highest expected return. Secondly, for any expected return, review all the portfolios that have that expected return. From that universe, select the one that has the lowest volatility. That is known as the efficient frontier.

This is the rationale behind our wealth management service.

To find out more about it, contact Kellands Gloucester.