Certified Plan Sponsor Professional (CPSP) Practice Exam

What is the primary goal of modern portfolio theory?

1. Maximizing return regardless of risk

2. Minimizing risk for any projected level of return

3. Eliminating all risks associated with investments

4. Investing solely in cash assets

The correct answer is: Minimizing risk for any projected level of return

The primary goal of modern portfolio theory is to minimize risk for any given level of expected return. This approach emphasizes the importance of diversification in reducing the overall risk of a portfolio while still aiming to achieve desired returns. By combining various assets that react differently to market conditions, investors can create a more stable investment outcome. Modern portfolio theory demonstrates that it is possible to construct a portfolio that optimizes returns for a specific level of risk. This is crucial for investors who want to ensure they are not taking on unnecessary risk while pursuing returns that align with their financial goals. The focus on the balance between risk and return is what sets modern portfolio theory apart from other strategies that might prioritize maximum returns without regard for the potential risks involved. This transactional philosophy leads to a more strategic approach toward investing, where understanding the risk associated with different investments becomes essential for effective portfolio management.