That means, at least theoretically, there is no best portfolio but rather an infinite number of best portfolios, depending on the risk one is willing to take. We know that everyone would like to have a portfolio with no risk and lots of return. Unfortunately, the real world of potential portfolios lies on or below the efficient frontier. So what does that mean for you?
Well, it means we have to do some planning, and then you’ll have a decision to make. First, as I said starting off, we need to make a best guess about what return your portfolio would need to earn over time to provide you with the money you need to accomplish all of your retirement goals. Then we need to make a best guess about your risk tolerance. If we just focused on your return needs, we might conclude it was possible to achieve your financial goals with a portfolio allocated 90% to stock, but that might not work out so well if we faced a major bear market in a few years. After you saw your nest egg lose 40%, you’d call us and say, “Harold, we can’t stand it. Please sell our stock and put our money in cash!”
That’s why we define risk tolerance as the point of pain and misery you can survive—with us holding onto your belt and suspenders—just before you make that call to tell us to sell out.