There’s a fundamental flaw in how financial professionals often approach investment management. It’s rooted in the distinction between risk and uncertainty, a difference that, while well known in academic circles, rarely gets the attention it deserves in client conversations. Frank Knight’s classic insight from “Risk, Uncertainty, and Profit” tells us that risk and uncertainty are two very different beasts, and our tendency to conflate the two leads to one major issue: we’re solving the wrong problem.
Let’s use marbles to illustrate the point.
Imagine I hand you a bag of marbles. In this bag, there are exactly 100 red marbles and 100 blue marbles. You close your eyes, reach in, and pull one out. You don’t know which color you’ll get, but the odds are perfectly measurable—50/50. This is risk. It’s quantifiable, predictable (in the statistical sense), and exactly the type of thing most traditional investment models are designed to handle.
Now, picture a second scenario. I hand you another bag of marbles, but this time I don’t tell you what’s inside. Could be 100 red marbles, or maybe 10, or maybe none. Maybe there’s a third color of marble in there that you didn’t even consider. This is uncertainty. You can’t measure it. You can’t calculate odds. You don’t know what you don’t know.
Life is the second bag. Markets are closer to the first. The problem is that investment models act like everything is the first bag.
We’re Asking the Wrong Questions
Our industry tends to act as though every financial decision can be boiled down to managing market risk—basically, figuring out how much volatility you can stomach in your portfolio. But when we focus so much on risk (volatility), we’re missing the bigger picture. Life’s uncertainties aren’t just about whether the market swings 10% in a given year. They’re about whether you are able to fund your lifestyle and handle the unexpected-job loss, healthcare expenses, or family member support. None of those things show up neatly in a risk tolerance questionnaire.
Traditional risk-based models assume that by managing the market’s ups and downs, advisors can manage your financial future. But here’s where that breaks down: clients primary concern isn’t as much about volatility. What you care about is whether your financial plan will help cover your lifestyle, the bills—today, tomorrow, and for the next 30 years.
Risk is measurable. Uncertainty is not. And most financial plans are far too focused on managing the measurable while leaving the unknowable (and often the most critical) parts of life unaddressed.
The Wrong Model for the Job
Let’s get real for a second. When an advisor asks, “What’s your risk tolerance?” they’re essentially asking, “How much short-term volatility can you handle before you panic?” This has little to do with your actual financial goals. Whether your portfolio drops by 10% in a bad quarter doesn’t tell us much about whether you’ll be able to cover your mortgage, fund your child’s college education, take your vacations, enjoy your life, or pay for long-term care in your later years.
Most clients aren’t sweating over volatility—they’re sweating over covering their expenses. Sure, volatility is uncomfortable, but the real problem is uncertainty. What if something unexpected happens that throws your entire financial plan out the window? What if the future you’re planning for today looks nothing like the reality you’ll face in 10, 20, or 30 years?
Here’s the uncomfortable truth: risk-based models solve the wrong problem. They’re designed to deal with measurable outcomes—what might happen to your portfolio in a given set of market conditions. But they don’t prepare you for the curveballs life throws your way—the uncertainties that can derail even the most well-built financial plans.
Life is Uncertain, and We Need to Prepare for That
Frankly, if all advisors are doing is managing a portfolio for volatility, they’re not doing enough. The focus needs to shift from minimizing risk to managing uncertainty. Financial planning should be about matching your assets to your liabilities—not just the measurable ones, but the uncertain ones too. This is what really matters: making sure that, come what may, you’ll have the resources you need to cover your expenses, fund your goals, and deal with life’s unpredictability.
In other words, we need to stop obsessing over volatility and start obsessing over whether your investment portfolio can handle the uncertainties that lie ahead. Traditional models focus on smoothing the ride, but clients don’t need a smooth ride—they need to get to the destination, no matter how bumpy the road gets.
Conclusion
If there’s one takeaway here, it’s this: we’re asking the wrong questions. The goal isn’t to manage portfolio volatility—it’s to help you navigate life’s uncertainties. We need to move beyond risk-based models that treat your future like a coin flip in a well-defined game. Life isn’t a game of predictable odds; it’s full of unknowns, and we should plan for it that way.
So next time you hear “risk tolerance,” think about what’s really being solved for. It’s time we start solving for the right problems—your lifestyle needs, your goals, and most importantly, the uncertainties that no model can predict. That’s where real financial planning begins.
John Grubbs, CAIA®, AAMS®
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