The Efficient Frontier represents a set of efficient asset class mixes based on historical results. Efficiency is defined as the lowest level of risk for each given expected return. Risk is defined as the standard deviation of annual returns. The Y axis represents growth and the X axis represents volatility. If your portfolio is inside the frontier, it means you are likely taking more risk than necessary. By owning a mix of assets which behave differently at different times, it may be possible to lower volatility without sacrificing expected return.
The efficient frontier is calculated based on historical results which may not be representative of future results. Target Allocations are designed to be close to the efficient frontier but are practical applications of Modern Portfolio Theory and may not be exactly on the efficient frontier.
Calculations are based on the long-term historical performance of asset class proxies: S&P 500, MSCI EAFE until 2000 and MSCI ACWI ex-US post 2000, 10 Year U.S. Treasuries, 10 Year Foreign Government Bonds, and 30 Day T-Bills. Alternative asset class is represented by a hypothetical index of 50% real estate and a 50% gold/oil combination. Data sources: Ibbotson Associates, MSCI, Standard & Poor’s, World Gold Council, BP.com, US Energy Information Administration, Robert Shiller Online, MIT Center For Real Estate, Yahoo Finance.