- Diversification helps control risk
- How investors can maximise utility
Following our previous article, in which we ran the rule over Modern Portfolio Theory ('Good investing habits that can boost your portfolio', IC 23 February 2024), the next step is to look at putting it into practice via some exchange-traded funds (ETFs). This will by no means be the end of the journey: there are more foundational topics, and we must graduate to postmodern portfolio theory before suggesting a portfolio mix we can hang our hat on. But first, it’s worthwhile examining how to think about personal risk tolerance and objectives in the context of the practical options for creating an optimal portfolio.
One of the core ideas we discussed in our last piece is that for any given set of investable assets, there exists a portfolio mix that achieves the optimal risk-reward trade-off. Investors can combine this with a risk-free rate of return to dilute risk further or (albeit this isn’t a good idea for private investors) they can borrow at the risk-free rate to leverage that ‘ideal’ portfolio.