Portfolio Optimization

This is the task of selecting assets such that the return on investment is maximized while the risk is minimized.

What is it?

Another word for portfolio optimization is "modern portfolio theory" or "optimal asset allocation". Regardless, the terms all refer to the idea that a portfolio should be built to yield the highest return possible while minimizing risk.
This means that spreading investment capital across a variety of assets will lead to a more balanced, risk-averse portfolio. Portfolio optimization should inherently lead to what investors call an "efficient portfolio," resulting in a portfolio that has the minimum amount of risk for the highest possible return for an investor.

Why is it Important?

Portfolio Optimization is good for traders who want to maximize the risk-return trade-off since this process is targeted at maximizing the return for every additional unit of risk taken in the portfolio.

What is Risk?

To keep things simple, risk is the chance of losing money on an investment that may or may not be expected in return. However, traders also measure risk through volatility, which refers to the likelihood an asset’s price will change significantly. This is one reason risk and reward often correlate. An asset with strong volatility can deliver or lose a great deal of value. That range of potential outcomes makes the asset hard to predict and, therefore, risky.

The Bottom Line

Portfolio optimization is an important part of creating an investing strategy, and managing it over time. It requires a sensible assessment of your desired returns, stage of life, risk tolerance, and investment preferences. Once you’ve established these values, you can work up numbers and percentages that reflect and, hopefully, support them.
Many investors can create and execute a portfolio optimization strategy on their own. That said, many more rely on professional help or algorithms to do this important work satisfactorily.