Two-fund separation
Principles of Finance glossary · Principles Of Finance
Definition
The CAPM result that every investor holds some combination of the risk-free asset and the market portfolio.
Two-fund separation in plain English
This is a surprising, tidy result from a famous investing theory (the CAPM). It says that no matter who you are — cautious grandma or bold risk-taker — the smartest mix is always just two ingredients: a totally safe asset (like a government bond) and one single "market portfolio" that owns a little of everything. The only thing that changes between investors is HOW MUCH they put in each — nervous folks hold more of the safe asset, daring folks tilt toward the market bundle. It's like everyone ordering from a two-item menu; you just adjust the proportions to match your appetite for risk.
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