Apply multifactor efficient-frontier theory to your portfolio

The market has a balancing point between different rates of return and risk or volatility. The efficient frontier refers to portfolio asset allocation which outperforms this mean. The goal is to find the optimal balance between returns and risk, seeking less risk and higher returns. For a graphic explanation of this point, see Figure 1. The straight line indicates the mean-variance frontier, the market's mean balance between average returns and volatility. Investors want allocations that place their portolios to the upper left of the chart, enjoying higher returns with less volatility. Investors using this traditional two-factor models can achieve efficient portfolios through a combination of two asset classes, equity index funds and risk free investments, including bonds and money market funds.

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The next step if for the investor to add additional pertinent factors in determining the portfolio's efficient frontier. For example, a small businessman might want equities that are less sensitive to a recession to hedge against the decline of his own business. This investor would be willing to sacrifice a certain degree of higher returns and lower volatility to gain safety in the event of a recession.
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