Modern Portfolio Theory
As money management developed over the last century, analysts began to shift their focus from the returns available from individual investments to the returns available from an entire portfolio. This approach became known as modern portfolio theory. Modern portfolio theory is based on the concept that investors are risk adverse. Through diversification of investments and asset classes, portfolios can be constructed with higher levels of expected return for each unit of risk assumed. Asset classes are divided into three main categories, stocks, bonds, and, cash and cash equivalents. Portfolio managers, through modern portfolio theory, can construct portfolios based on various allocations over the three main asset classes whose return will be the greatest given each unit of risk.