Modern Portfolio Theory

Modern portfolio theory, a rather obtuse concept, says investors can build a portfolio that maximizes expected returns for a given level of risk. The theory is the basis upon which mutual funds classify funds according to risk/reward categories.

For a very technical treatment of the subject read:

Modern Portfolio Theory and Investment Analysis by Edwin J. Elton, Martin J. Gruber, Stephen J. Brown, and William N. Goetzmann.
Portfolio Theory and Capital Markets by William Sharpe.