Modern Portfolio Theory
Developed by Nobel Laureate Harry Markowitz in the 1950s and later refined by other economists, Modern Portfolio Theory remains fundamental to the financial industry. By definition, Modern Portfolio Theory explains how to optimize portfolio returns for any given level of market risk. One principle of investing and the theory emphasizes that greater potential returns are associated with higher risk and conversely, the lower the risk, the lower the return. Within the framework of MPT, an optimal portfolio is constructed on the basis of asset allocation, diversification and rebalancing. For each level of risk, an optimal asset allocation is designed to produce the greatest tradeoff between risk and return. Needless to say, the optimal portfolio will provide neither the greatest returns or the lowest risk, but an optimal balance residing on the Efficient Frontier.
As most of the major digital asset managers adhere to Modern Portfolio Theory, ...
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...alue, rebalancing back to its target allocation intends to optimize returns for the initial level of risk. In the past, rebalancing drew criticism due to the costs of conducting transactions. However due to low overhead costs, automated advisors can provides transactions free of charge and automatically rebalance portfolios. As research suggests, rebalancing can significantly lower the risk of a portfolio.
Granted many of us cannot afford the services of traditional financial advisors, technology has democratized investing for the middle class. With the advancement in technology and sound academic research, automated services are redefining how we invest. Since many automated platforms base their portfolios on Modern Portfolio Theory, financial concepts of diversification, rebalancing, and asset allocation play a major part in constructing the optimal portfolio.
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