When it comes to investing, most people focus on the positions they own. They talk about how they crushed it with a hot stock pick or timed a trade just right. You never hear someone over lunch or a round of golf say, “You wouldn’t believe how low my portfolio’s correlation coefficient is!” No one brags about being diversified. It’s not exactly cocktail conversation material. (And selective memory buries the losers.)
But while individual positions may win bragging (or losing) rights, it’s the portfolio that determines whether you meet your financial goals. That’s where the real work and the real value lives.
Timeless Insight
In the 1950s, economist Harry Markowitz laid the foundation for what became known as Modern Portfolio Theory (MPT). His idea was simple but profound: don’t evaluate investments in isolation. What matters is how each piece contributes to the whole.
Markowitz recognized that portfolio risk isn’t just the average risk of each investment. It also depends on how those investments behave relative to one another—what we call correlation. When assets don’t move in perfect sync, they can smooth out each other’s rough patches. The result: potentially higher returns for a given level of risk, or the same return with less stress along the way.
That’s real diversification. Not just owning more things, but owning the right things—those that respond differently to different economic and market environments.
Let’s make it concrete. Suppose you have two investments:
- Asset A: Expected return of 9%, higher volatility
- Asset B: Expected return of 6%, lower volatility
- The two aren’t highly correlated—they zig and zag at different times.
It may be surprising to know that combining some of the riskier asset A with less risky assets B can actually make your overall portfolio less risky than owning only B without sacrificing any expected return. Think about that for a moment.
Or if you want to target a higher return, you could apply modest leverage to the diversified mix and still end up with a better risk-adjusted outcome than simply going all-in on Asset A.
What was once only available to institutions or hedge funds is now increasingly accessible to a broader mix of investors. A new generation of ETFs allows savvy investors to apply leverage to well-diversified portfolios—essentially adding some “umph” to the efficient frontier. When used responsibly, this approach can help target higher returns with more balance and less drama than traditional portfolios seeking higher returns.
This concept forms what’s called the “efficient frontier”—the set of portfolios that offer the most return for the least amount of risk. In theory, that’s the holy grail.
When Theory Meets Reality
Here’s where it gets less elegant. Building the “perfect” portfolio requires knowing future returns, volatilities, and correlations. Spoiler alert: we don’t. We can make informed estimates, but even small errors in those assumptions can lead to big changes in the outcome.
Portfolio optimization can be like a fussy chef—change one ingredient slightly and the whole recipe can turn out differently. This sensitivity makes purely mathematical optimization prone to unrealistic results unless guided by sound judgment and constraints.
And then there’s the real world. Take 2022, for example. For decades, investors relied on traditional stock and bond strategies to balance each other out. But in 2022, both went down—a lot. Bonds didn’t act as the stabilizer many expected. It was a painful reminder that historical relationships can break down.
The point isn’t to discard diversification. It’s to apply it with a broader lens. Non-traditional assets and strategies helped weather 2022 and can add diversification to your traditional portfolio.
The core lesson of Modern Portfolio Theory remains valid: diversify with purpose. And not just by adding more line items. True diversification comes from owning things that respond differently to various risks—economic growth, inflation, policy changes—not just historical correlation data.
Treasuries still behave differently than stocks much of the time. But other diversifiers, like alternative strategies—trend-following, market-neutral funds, or even certain types of private investments—can also play a meaningful role. The goal is to blend sources of return that don’t all rise and fall together.
It’s not about engineering perfection. It’s about building a resilient whole.
Portfolio, Portfolio
While many investors think like stock pickers, the prudent approach is to construct like a portfolio architect. Each position is selected not for its story, but strategically for its function—how it fits into the bigger picture. This portfolio design may not win you any golf course glory, but, done well, probabilities are that it’ll lead to greater wealth over time.
And while your brother-in-law might keep talking about his latest winner (while omitting his losers), we’ll keep building portfolios that help you retire on your terms, send kids or grandkids to college, or fund your philanthropic goals. We’ll keep focusing on the structure that helps you reach your destination with more confidence and less drama.
Because in the end, it’s not the position that matters. It’s the portfolio.
