“Risk and return are related.” That was the soundbite of the20th century, the mantra of Modern Portfolio Theory. Whetherthrough those ubiquitous risk tolerance questionnaires or nearlyany portfolio optimization software package, in one way or another,most professionals have been trained to use the mathematicalequivalent of risk to plot investment strategies.
There's only one problem: It's all wrong.
Our use of risk fails in two ways. First, the industry hasvastly misinterpreted the definition of the risk/returnrelationship. It has implied an absolute correlation between realrisk and real returns exists. In truth, it's always been theperceived risk that's related to the expectedreturn. Indeed, academic studies upon which many have based the useof risk tolerance questionnaires specifically warn against theiruse. Maybe the marketing guys forgot to read the fine print.
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