Efficient Frontier

The Efficient Frontier is a cornerstone concept in Modern Portfolio Theory (MPT), introduced by Harry Markowitz in 1952. It represents the set of portfolios that offer the highest expected return for each level of risk, or equivalently, the lowest risk for each level of expected return.

When you combine multiple assets into a portfolio, the resulting risk-return profile depends not only on each asset's individual characteristics but critically on the correlations between them. Assets that move independently or inversely can be combined to reduce overall portfolio risk below that of any single asset — this is the power of diversification.

Portfolios that lie on the efficient frontier are considered "optimal" because no other portfolio offers a better risk-return tradeoff. Portfolios below the frontier are suboptimal — you could achieve higher return for the same risk, or lower risk for the same return.