MPT is a useful tool for investors that are trying to build diversified portfolios. It allows investors to produce more efficient portfolios that deliver a certain level of return for the least amount of risk.
Every possible combination of assets can be plotted on a graph, with the portfolio’s risk on the X-axis and the expected return on the Y-axis. This reveals the most desirable portfolio.
For example, if Portfolio A has an expected return of 15% and a standard deviation of 9%, while Portfolio B has an expected return of 15% and a standard deviation of 8%, then portfolio B is preferable.
Investors can use MPT to identify an efficient portfolio that meets their risk tolerance and desired level of return. MPT calculates the percentage of each asset that must be held in the chosen portfolio.
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