If you're like most investors approaching or in retirement, you've probably been told that managing volatility is critical to protecting your wealth. Your advisor may have focused on maximizing "risk-adjusted returns" or building a portfolio with an optimal Sharpe ratio, which is a measure of volatility- adjusted returns.
But here's a question worth considering: what if volatility isn't actually your primary risk?
Where Volatility Became Synonymous with Risk
The investment industry's fixation on volatility traces back to Modern Portfolio Theory (MPT), which uses standard deviation as a convenient, quantifiable measure of risk. It's mathematically elegant, and it allows advisors to construct portfolios that maximize returns for a given level of volatility. The problem? This framework was never designed to solve the retirement problem.
Even the founder of MPT, Harry Markowitz, has said so. It was designed for institutional investors, not individuals.
Here's the fundamental disconnect: it's entirely possible to have a portfolio with an excellent Sharpe ratio that still fails to accomplish your actual goal. If that portfolio can't reliably fund your retirement spending—or the legacy you want to leave—then those risk-adjusted returns are irrelevant. Yet this is precisely how most asset allocation is determined, even if we could accurately measure risk tolerance, which is a topic for another day.
Redefining Risk for What Actually Matters
If you believe, as I do, that wealth is simply a means to an end—funding your future spending needs and bequests—then the real risk is not meeting those future spending goals.
Think about it: a good chunk of your spending needs are relatively fixed. You need to cover living expenses, healthcare costs, travel plans, and some minimum level of lifestyle you've envisioned for retirement. Volatility becomes a problem when it threatens your ability to meet those fixed obligations. The risk you should be managing isn't market fluctuations—it's spending volatility, the possibility that market downturns force you to cut back on the life you planned.
Why would we use volatile assets to fund these fixed expenses?
A Different Approach
This is why I advocate for asset matching instead of traditional volatility-focused allocation. The principle is straightforward: match fixed spending needs with fixed-return assets and reliable income sources. Does volatility matter? Yes—but only after you've secured your essential spending needs. It comes later in the process, not first.
This approach inverts the conventional wisdom. Rather than asking "How much volatility can you tolerate?" and building a portfolio around that answer, we start by asking "What spending do you need to secure?" and build from there. The result is a strategy actually designed to solve your problem, not just optimize an academic measure of risk.
An Invitation to Reconsider
I'm not suggesting that decades of portfolio theory are worthless—MPT has its place. But if you're in or approaching retirement, it may be time to question whether the traditional approach is truly aligned with what you're trying to accomplish. Your goals deserve a framework that was built for them.
