Fall 2004, Vol 29, No 3

Abstract: Modern portfolio theory (MPT) began in 1952 with the publication of an important article by Harry Markowitz. Markowitz was the first researcher to prove the old adage “Don’t put all your eggs in one basket.” Essentially, he proved mathematically that by diversifying investments, the investor can lower the risk of the investment portfolio, or conversely, earn a higher return for the same amount of risk as an undiversified portfolio. Perhaps more important than proving the common sense adage,Markowitz gave us the tool by which we could measure the benefits of diversification. Put simply, the objective of the investor is either to minimize portfolio risk subject to a target rate of return or to maximize the return on the portfolio subject to a target level of risk. To do this, the investor uses mean-variance portfolio analysis. This analysis can tell us how many eggs to put into which basket.