What is an efficient portfolio?
An efficient portfolio, also known as an ‘optimal portfolio’, is one that provides that best expected return on a given level of risk, or alternatively, the minimum risk for a given expected return. A portfolio is a spread of investment products.
If, given a particular level of risk, the expected returns are not met, or if the risk required to achieve that expected level of return is too high, it is called an ‘inefficient portfolio’.
American economist Harry Max Markowitz (born 1927), a recipient of the 1990 Nobel Memorial Prize in Economic Sciences, who introduced the Modern Portfolio Theory in 1952, said that the holder of an efficient portfolio cannot diversify any further to increase the expected rate of return without accepting a higher level of risk.
“A good portfolio is more than a long list of good stocks and bonds. It is a balanced whole, providing the investor with protections and opportunities with respect to a wide range of contingencies.” (Harry Markowitz)
Most portfolio managers and professional investors say that although the concept of an efficient portfolio is useful to understand, in real life it is more academic than practical.
The Nasdaq Business Glossary says the following about the ‘Markowitz efficient portfolio’:
“Also called a mean-variance efficient portfolio, a portfolio that has the highest expected return at a given level of risk.”
Markowitz says an efficient portfolio should have a combination of at least two stocks above the minimum variance portfolio (a portfolio with the lowest possible risk level for the rate of expected return).
Video – Optimal Portfolios