Efficient Frontier

The efficient frontier is a concept in modern portfolio theory introduced by Harry Markowitz and others in the early 1950s.

The higher the potential returns the higher the risk. To earn returns that beat inflation you generally need to accept a degree of risk with your money. The key is in understanding how much risk you are comfortable with and taking measures to control the risk to which you are exposed.

Investing in equities can be volatile. However, if you look at stock market returns over the long term, you will see that there is generally an upward trend.

A better option than only investing in equities is to spread your money between several different types of asset, typically including equities, property, fixed interest and cash. Diversifying your portfolio can help to reduce risk and increase your potential for returns. This is because different types of asset often behave differently under the same economic conditions. If you therefore invest in several types of asset, it’s likely some will perform well even if the rest are temporarily declining.  

This is where the concept of the efficient frontier comes in. The efficient frontier describes the relationship between the return that can be expected from a portfolio and its risk. The ‘optimal’ portfolio works in two ways. Firstly, for any level of volatility, review all the portfolios that have that 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 set of optimal portfolios is called the efficient frontier.

In essence this is the driving force behind our wealth management service.

To find out more about it, Contact Kellands Bristol.