2 An introduction to portfolio construction

This chapter covers

Creating risk–reward plots
Using matrix operations to compute portfolio returns and volatilities
Calculating, plotting, and deriving the math behind the efficient frontier
A risk-free asset and the capital allocation line

One of the primary functions of a robo-advisor is to construct a well-diversified portfolio of assets. This chapter will provide the theoretical foundation for portfolio construction and some building blocks we will use later. We will also start using Python in our examples. Later in the book, we will delve deeper into the topic of portfolio construction, including some problems with the traditional methods that are covered in this chapter.

2.1 A simple example with three assets

2.2 Computing a portfolio’s expected return and standard deviation

2.3 An illustration with random weights

2.4 Introducing a risk-free asset

2.5 Risk tolerance

Appendix

No risk-free rate

Adding a risk-free rate

Summary