Beyond Markowitz: A Comprehensive Wealth Allocation Framework for Individual Investors
By ASHVIN B. CHHABRA
The principles of Modern Portfolio Theory, as outlined in Markowitz’s famous 1952 paper (Markowitz [1952a]) speak clearly and unambiguously to the benefits of portfolio diversification. There is an optimum way to create a portfolio by combining different asset classes. This construction depends crucially on the market risk and return of each asset class and on the correlations between different asset classes. These optimal portfolios, when mapped on the risk-return plane, form a curve known as the efficient frontier. Each investor, based on his personal utility function, finds the appropriate point on this line, which then prescribes an optimum allocation between different asset classes such as stocks, bonds, and cash.