Efficient Frontier

The efficient frontier is a concept in modern portfolio theory that represents the optimal combinations of risk and return that are possible with various portfolios. Every possible investment portfolio can be plotted on a graph of risk and reward. As greater diversification is achieved the risk/reward trade-offs get better. If you could plot every possible portfolio you would find that there is a theoretical limit to the return that can be achieved with any given level of risk. There is a curve that represents the highest possible returns that are achievable for each level of risk and this curve is called the efficient frontier, as depicted in the graph below. Portfolios that lie along the efficient frontier are called efficient portfolios - a term coined by Harry Markowitz.

Sophisticated portfolio management tools are now available to allow you to compare different portfolios to determine if they are on the efficient frontier and, if so, where they are.