A tool used in portfolio management helps investors find the optimal balance between risk and return. It identifies the set of portfolios that offer the highest expected return for a given level of risk, or the lowest risk for a given expected return. For example, an investor might use such a tool to compare different asset allocations and identify the portfolio that maximizes potential profit while staying within their risk tolerance.
This optimization process is crucial for informed investment decisions. By visualizing the trade-off between risk and reward, investors can construct portfolios aligned with their financial goals and risk appetite. Modern portfolio theory, developed in the mid-20th century, provides the theoretical foundation for this optimization, revolutionizing how investment decisions are made. It empowers investors to move beyond simple diversification and actively manage risk for optimal performance.
