Dealing with risk just like a doctor deals with pain

How would you feel if your portfolio fell 25%? This is the type of question you get asked to determine your risk tolerance.

- Matthew Matthee

Would losing 25% of your portfolio be painful? Would you panic and sell out of your portfolio to limit losses? Then, you have a low risk tolerance.

Would you take it on the chin and even add to your portfolio when it's down? Then, you have a high risk tolerance.

This is the traditional way of thinking about risk.

I disagree with this traditional way of thinking about risk tolerance and trying to determine a client's risk profile and, consequently, their optimal portfolio.

I get the implied logic, but this type of profiling seems misleading in how it makes us think about risk. It makes it worse that these surveys are a regulatory requirement in our industry.

I'll give you two examples illustrating why these surveys are misleading.