COLUMN - How would you feel if your portfolio fell 25%?

If that would keep you up at night, you have a low risk threshold. If you'd shrug and buy more, you have a high risk threshold. Somewhere in between and you're "balanced." 

This is the traditional way of thinking about risk. A questionnaire determines your profile, your profile determines your portfolio, and the assumption is that everyone ends up in the right place. 

I think that gets it backwards.

The problem is that this framework is useful only up to a point, and often misleading beyond that.

People don't choose risk. They avoid extremes.

When you present people with three portfolio options, low, medium, and high risk, most choose the middle. Fine. But remove the high risk option and replace it with something even more conservative, so now the choices are very low, low, and medium. What happens? 

People still choose the middle.

They're not expressing a genuine preference. They're just avoiding the extremes. The questionnaire isn't measuring risk tolerance. It's measuring anchoring bias.

The bigger problem

Risk surveys ask the wrong question entirely.

You don't take risk with money. You take risk with your consumption of life. What is money for, after all?

The real question isn't how you'd feel about a 25% portfolio drop. It's how you'd feel about your kids not getting into the school you wanted for them, or having to downgrade your house, or cutting back on medical cover in retirement.

Those are the real risks. And yet when you ask people about portfolio risk versus life risk, you get completely different answers, even though you're asking about the same thing.

What a financial adviser is actually for

A financial adviser should function like a doctor. A licensed professional whose job is to guide you toward the right outcome, not the most comfortable one.

Imagine going to your doctor and saying you hate pain. A good doctor doesn't say "fine, no treatment then." They say "you need this procedure, but I'll manage the pain." 

They give you anaesthetic. They give you something for the recovery. But they give you the treatment.

The same logic applies here. If you come to me and say you can't stomach market volatility, I'm not going to pretend that holding 80% in cash is a proper long-term plan if it quietly creates a much bigger problem later. 

I'm going to help you not watch your portfolio every day, understand what short-term drops actually mean in context, and stay the course.

What I won't do is condemn you to a worse retirement because of how you feel about a hypothetical 25% drop.

Risk as an output, not an input

Here's how I think about it instead.

Start with your life. What does retirement actually look like for you? Where do you want to live, what do you want to do, what does financial security mean in practical terms? 

Once we know that, we can calculate what you need, and the required return from your portfolio becomes clear. The risk follows from the goal. It's an output, not a starting point.

Asking how you feel about risk before establishing what you're trying to achieve is like asking a builder how he feels about heights before you've told him what you're building.

The real question

Feelings matter. If a portfolio is so uncomfortable that you abandon it at the wrong time, the plan has failed. Behaviour matters enormously.

But feelings should not be the only input. The purpose of financial planning is not to optimise your comfort today. It is to improve the probability of achieving the life you want tomorrow.

The real question is not: how much volatility can you tolerate?

The better question is: what future are you trying to fund, and what investment strategy gives you the best chance of getting there?

That is a very different conversation. And usually, a much more useful one.

Matthew Matthee has a wealth management business that specialises in retirement planning and investments. He writes about financial markets, investments, and investor psychology. He holds a Masters Degree in Economics from Stellenbosch University and a Post Graduate Diploma in Financial Planning from UFS. [email protected]    

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