Out of a variety of risky investments, an investor can compile an effective portfolio of investments, each of which will offer the maximum possible expected return for a given level of risk. Investors are therefore supposed to keep one of the optimal portfolios on the effective level and the rest to adjust to the market risk. The latter is reached through the leverage or de-leverage of that portfolio with positions in a risk-free investment such as government bonds.
The following paper presents the utility of the MPT for contemporary decision making. The objective of the investor is discussed to find an effective allocation of assets and liabilities which implies an investor’s balance and efficiency of an investment.
Active portfolio managers constantly buy and sell a great number of common stocks. Their job is to try to keep their clients satisfied, and that means consistently outperforming the market so that on any given day if a client applies the obvious measuring stick—“How is my portfolio doing compared to the market overall?”—the answer is positive and the client leaves her money in the fund. To keep on top, active managers try to predict what will happen with stocks in the coming six months and continually churn the portfolio, hoping to take advantage of their predictions. On average, today’s common stock mutual funds own more than one hundred stocks and generate turnover ratios of 80 percent (Lewis, Mizen 2000).
Index investing, on the other hand, is a buy-and-hold passive approach. It involves assembling, and then holding, a broadly diversified portfolio of common stocks deliberately designed to mimic the behavior of a specific benchmark index, such as the Standard &. Poors 500 Price Index (S&.P 500).
Compared to active management, index investing is somewhat new and far less common. Since the 1980s, when index funds fully came into their own as a legitimate alternative strategy, proponents of both approaches .have waged combat to determine which one will ultimately yield a higher investment return.