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Intermediate track
IntermediateLesson 17

The efficient frontier

The efficient frontier

For every level of risk there’s a best-possible mix — and together they form a curve.

In short

Plot every possible mix by its risk and its reward. The ones giving the most reward for each level of risk trace a curve — the efficient frontier. You want to be on it.

The idea that smart investing is about the best trade-off between risk and reward — not chasing the single highest return — is the heart of modern portfolio theory.[1]

rewardbumpinessbest balance
The curve shows the best reward you can get for each level of bumpiness.
The efficient frontier — try it
risk →returnbondsstocksmin risk

Drag the correlation down and watch the curve bend left — that bend is diversification turning into free risk reduction.

Any mix below the curve is wasteful: you could earn more for the same risk, or the same for less risk. The curve is the set of “no regrets” choices.

Like the list of record times for each distance at a track meet. Running slower than the record for your distance just leaves performance on the table.

Where you sit on the curve is personal — it depends on how much bumpiness you can stomach. The frontier just keeps you from leaving free reward behind.

Where these numbers come from

Finisdom’s Allocation Explorer draws this curve from real history and marks the standout mixes — but it’s research, not a promise about the future.

Open the Allocation ExplorerPart of the Finisdom app — sign in to open it.

Check your understanding

What does a mix “on the efficient frontier” give you?

Sources & further reading

  1. 1.Harry Markowitz (1952) Portfolio Selection — The Journal of Finance — Introduced the efficient frontier; Markowitz later shared the 1990 Nobel Prize in Economics.

Related

Why diversification actually worksBeta and the price of riskWhen the optimizer fools you

Tripped up by a word? Look it up in the glossary.

Learning only — not investment advice.