Frontier | What is the "Efficient Frontier"? Why are investors using it?

Question

Have you ever thought about how to configure an investment portfolio to make money while not taking too much risk? This is the problem that the “Efficient Frontier” aims to solve.

The core concept is very simple

The efficient frontier refers to the set of portfolios that offer the highest expected return for a given level of risk. In other words, it helps you find the optimal balance between return and risk.

This theory was proposed by Nobel Prize-winning economist Harry Markowitz and has now become the cornerstone of modern portfolio theory.

How to use? Three strategies

1. Optimize Configuration Ratio The effective boundary is based on historical data and asset correlation, calculating what proportion each asset should occupy. For example, if you buy stocks + bonds + crypto assets, it can tell you how much each should occupy for optimal results.

2. Determine the appropriate degree of dispersion With the same expected rate of return, the higher the degree of diversification, the lower the risk - this is the magic of diversified investment. The efficient frontier can suggest how much you should diversify based on your risk tolerance.

3. Identify Revenue Bottlenecks When you continue to increase your position in an asset, the risk increases but the returns do not correspondingly improve, this is known as diminishing marginal returns. The efficient frontier can help you identify this critical point.

Restrictions Must Be Known

This theory has a fatal flaw: it relies entirely on historical data. Past trends do not guarantee that the future will repeat, especially in an era of frequent black swan events. Moreover, it assumes that returns follow a normal distribution, but in reality, there are often extreme fluctuations—just look at the pandemic in 2020, the crypto winter in 2022, and the AI wave in 2024; which of these did not break the norm?

Conclusion

Effective boundaries are an important reference tool for portfolio management, particularly suitable for helping clients understand the truth that “higher risks do not always lead to higher returns.” However, do not treat it as an absolute truth — it is essential to flexibly adjust based on real-time market data and individual circumstances.