What is Asset Allocation
and Modern Portfolio Theory?
Modern Portfolio Theory (MPT) is the concept of diversification, with the goal of selecting a mix of investment assets that has collectively lower risk than any one asset. Different types of assets often change in value in opposite ways. For example, when prices in the stock market fall, prices in the bond market may increase, and vice versa. A collection of both types of assets can therefore have lower overall risk than either individually. MPT was developed in the 1950s through the early 1970s and was considered an important advance in the mathematical modeling of finance. But nearly 60 years later, many theoretical and practical criticisms have been leveled against it. These include the fact that financial returns do not follow a predictable symmetric distribution, and that correlation between asset classes are not fixed but can vary, especially during crises. Simply put, having your eggs in many different baskets won’t help if all the baskets are dropped and the eggs get broken.