At Landaas and Company we feel that Modern Portfolio Theory is one of the most important and influential economic theories dealing with finance and investment. In 1952, Modern Portfolio Theory was developed by Harry Markowitz.  It is not enough to look at the expected risk and return of one particular stock. By investing in more than one stock, an investor can reap the benefits of diversification - chief among them, a reduction in the riskiness of the portfolio. Modern Portfolio Theory quantifies the benefits of diversification, also known as not putting all of your eggs in one basket.

In other words, Markowitz showed that investment is not just about picking stocks, but about choosing the right combination of stocks among which to distribute one's nest egg.
For a well-diversified portfolio, the risk - or average deviation from the mean - of each stock contributes little to portfolio risk. As a result, investors benefit from holding diversified portfolios instead of individual stocks.

Modern portfolio theory takes this idea even further. It suggests that combining a stock portfolio that sits on the efficient frontier with the purchase of bonds you can actually increase returns and control your risk beyond the efficient frontier. The chart below illustrates how Modern Portfolio Theory can maximize returns without taking inordinate risk.