Modern Portfolio Theory (MPT) is an investing model in which investors invest with the motive of taking the minimum level of risk and earning the maximum amount of return for that level of acquired risk. The modern portfolio theory is a helpful tool for the investors as it helps them in choosing the different types of investments for the purpose of the diversification of the investment and then making one portfolio by considering all the investments.

For Example:There is an individual who wants to invest in a portfolio. Investors got an option of two portfolios which are as follows:

The first portfolio consists of a mix of the bonds and different stocks that gave the return of 10 % annually on an average, but at the same time differed by the range of as much as 15 % annually (returns, in this case, usually differed between -5 % and + 25 %).

On the other hand, the second portfolio consists of a mix of the bonds and different stocks that gave the return of 10 % annually on an average, but at the same time differed by a range of only 3 % annually (returns, in this case, usually differed between 7 % and 13 %)

In both scenarios, the average expected return on the investment is 10 %. In the first portfolio, one could get the return of as much as 25 %, which sounds attractive, but at the same time, there prevails a huge risk where one might lose 5 % as well because the range usually differs between -5 % and + 25 %.

On the other side, in the case of the second portfolio, a less return range of between 7 % and 13 % may be less attractive to the investor, but in that case, it is expected that one will not lose his money, which makes the investment less risky than the first portfolio.

According to the Modern portfolio, theory investor invests with the motive of taking the minimum level of risk and earning the maximum amount of return with that minimum risk taken, so in the present case, one should choose the second portfolio as he is getting the same average expected return with the less level of risk.