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Chapter 12. Managing Your Investments > Efficient Frontier and Portfolio Divers...

Efficient Frontier and Portfolio Diversification

Another measuring stick, if you will, is the concept of modern portfolio theory, also called the Efficient Frontier. Do you see what you're missing by not sitting in meetings with asset managers and quantitative analysts? Sarcasm aside, you can also see how time consuming and difficult it can be to manage your own retirement planning and investing. Of course, you could just throw darts at the stock section of the Wall Street Journal, but most of us realize that to reach our goals, we need to take this task seriously because the consequences have such a great impact. Let's go back to the Efficient Frontier.

The essence of Efficient Frontier is an investment strategy based on the relationship of several risk factors applied to an overall portfolio of investments. The analysis is called optimizing your portfolio and analyzes an investment's alpha, beta, and r-squared compared with the other investments in a given portfolio. In other words, this theory suggests that the risk of a particular investment should not be looked at on a stand-alone basis, but rather in relation to how that particular investment's price varies with the price of the entire portfolio. Now let's try to make some sense of this all, briefly.


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