What is a key concept of modern portfolio theory?

A key concept of modern portfolio theory is that investors can optimize returns for a given level of risk through diversification. This theory, developed by Harry Markowitz in the 1950s, emphasizes the importance of not just considering individual asset returns but also focusing on how different assets interact in a portfolio. By combining a variety of asset classes with different risk and return profiles, investors can reduce overall portfolio risk while maintaining or even enhancing expected returns.

The foundation of this theory rests on the idea that risk is not only determined by the volatility of individual assets but also by how those assets correlate with one another. When assets with lower correlations are combined, the total portfolio risk can be minimized without sacrificing potential returns. This diversification effect is crucial for effective portfolio management.

The other concepts mentioned do not align with the principles of modern portfolio theory. For instance, the assertion that risk cannot be measured objectively overlooks the various quantitative methods available for assessing risk. Similarly, the idea that all assets should be equally weighted contradicts the concept of strategic asset allocation based on individual asset characteristics and investor risk tolerance. Lastly, advocating that long-term investments do not require periodic reviews undermines the necessity of adjusting portfolios in response to market changes and personal financial situations.