Understanding the Efficient Frontier

The Efficient Frontier represents the best possible portfolios: those that provide the highest return for the least amount of risk.

How Portfolio Return Works

A portfolio’s return is based on the returns of the stocks it contains, weighted by how much is invested in each.

Why Correlation Matters

• Low correlation → Stocks move independently, helping reduce overall risk.
• Negative correlation → When one stock goes up, another goes down, creating strong diversification.
• High correlation → Stocks move together, reducing diversification benefits.

How Portfolio Risk is Determined

• The individual risk of each stock.
• The weight of each stock in the portfolio.
• The correlation between stocks.

Lower correlation leads to better diversification and lower overall risk.