Today, we’re talking about a core concept in investing: the relationship between risk and return, and why a thoughtful allocation strategy is essential to your long-term success.
When we talk about returns — the growth of your investments over time — it’s important to understand that higher potential returns come with higher levels of risk. This is a basic principle of investing: if you want the possibility of greater rewards, you must be willing to tolerate more uncertainty along the way.
But this doesn’t mean you should chase returns blindly or avoid risk entirely. That’s where Modern Portfolio Theory, introduced by economist Harry Markowitz, offers valuable insight.
Markowitz’s theory, which earned a Nobel Prize, focuses on how investors can build portfolios that optimize returns for a given level of risk through diversification. Rather than trying to pick individual winners, it emphasizes the benefit of combining investments that behave differently — for example, stocks and bonds — to reduce overall volatility while still pursuing growth.
In other words, it’s not just about selecting good investments, but selecting the right mix of investments that work well together.
One of the most important concepts from Markowitz’s work is called the Efficient Frontier.
The Efficient Frontier is a curve on a graph that represents the set of optimal portfolios — those that provide the highest expected return for a given level of risk, or the lowest risk for a given level of return. Portfolios that fall below the frontier are considered suboptimal — they’re either taking on too much risk for the return they’re generating, or they’re not earning enough return relative to the risk.
As financial planners, one of our goals is to help you build a portfolio that sits on the efficient frontier — not just chasing returns, but taking smart, deliberate risks that align with your goals and tolerance.
To make this concept more relatable, let me offer a quick analogy — one that golfers may appreciate.
Imagine you’re in a two-player best ball format. One golfer plays conservatively, keeping the ball safely in play to avoid a large number. The other plays more aggressively, going for tough pins or longer carries. If both players took the same approach, you might miss opportunities — or face unnecessary risk. But when each person plays to their strengths and balances the other out, you create a team that’s not only competitive but adaptable.
That’s diversification in action — and it’s how a well-allocated portfolio behaves. Some investments provide stability, others provide growth, but together, they create a more efficient and resilient investment strategy.
With the ongoing geopolitical uncertainty — from global conflicts to shifting trade dynamics — markets are experiencing heightened volatility. This reinforces the value of diversifying across regions and asset classes. While some markets may face headwinds, others offer unique opportunities.
So, what does this mean for you?
Your allocation — the mix of stocks, bonds, and other assets — should reflect three things:
- Your goals — What are you investing for, and when do you need the money?
- Your time horizon — How long can your money stay invested?
- Your comfort with risk — How do you feel when markets fluctuate?
A well-constructed portfolio balances these factors so you’re not taking unnecessary risks, but also not missing opportunities for growth.
