What is the efficient frontier? It shows you the best portfolio mix between stocks and bonds, or Stock to bond ratio. You are probably familiar with the phrase, “No pain, no gain” if
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What is the efficient frontier? It shows you the best portfolio mix between stocks and bonds, or Stock to bond ratio. You are probably familiar with the phrase, “No pain, no gain” if you work out in a gym. Or the phrase, “Nothing ventured, nothing gained” when it comes to business. This basically means that you have to take some risk, to get some reward.
This is also true in investing, that risk is proportional to returns. You usually get higher returns if you are willing to take higher risk. For example, the stock market has higher returns than butting your money in treasury bonds, but it also means you take on higher risk. Or does it?
Modern portfolio theory has a way where you can have your cake and eat it too, meaning, you can get a higher return and lower your risk is certain circumstances. If you put $100 in a savings account at a bank in the united states, which essentially has no risk, because it is FDIC insured, meaning the US government guarantees that your $100 will never go down in value. The average interest you will get in it in the U.S. is 0.1%. This means that at the end of the year, your savings account will be worth $100.10.
If you put your money in the US stock market, which can have high risk, meaning it can fluctuate quite a bit, and nothing is guaranteed, at the end of the year, you could have a portfolio value of as much as $138 as would have happened in 1995, or $63 as would have happened in 2008. This fluctuation in value of principal is called risk. But on average, if you didn’t touch the money, you would have an annual return of about 7%. After an average 10 year period, your $100 would be worth $200 if invested in stocks. In the bank after 10 years, your $100 would be worth a whopping $101.05.
Where you invest depends on your tolerance for risk. If you think you would pull all your hair out watching the stock market drop the value of $100 to $63 because you needed the money for something, then the stock marke