IPS: Ability to take risk

Hi, Is there a systematic way in defining the client’s ability to take risk? I find this area very frustrating as there is no place in the text that define the “average”. Thanks for your help.

No

IN a real world, there is a systematic way of defining ability and willing to take risk. In the CFA world, it is based on ‘gut’ feeling…

bpdulog Wrote: ------------------------------------------------------- > No Love it!

If person is young, then ability is usually above average (mention human capital if you can, CFAI loves this term) If asset base is very large, above average If there is no need to start withdrawing from portfolio right away, above average If retired, below average If portfolio is sole source of income, below average (unless portfolio size is really, really big relative to expenses) Pray you get a young person or couple (above average) or a super wealthy person (above average). Above average tolerance is usually clear cut. Average or below average is tougher to gauge. If you get a retired person and can’t decide what their tolerance is, go with below average.

I love the “large assets relative to expenditures” bullshit they throw out at you. How the fuck can you say assets are large if you have say $50 mm in assets and annual expenditures of $3.5 mm, with inflation of 3%. That is a nominal after tax required return of 10%, the average s&p return for like 80 years is about 7% (pre tax). This is the most arbitrary shit I have seen in these books. The willingness / ability section is by far the most ridiculously subjective I have seen yet.

One thing I have notice based on EOC questions, even though they have large asset base 20x expenses but if their income is less than expenses and around age 50, inspite of long term and good asset base, CFA defines as average risk

If I saw this on a test: “…you have say $50 mm in assets and annual expenditures of $3.5 mm, with inflation of 3%. That is a nominal after tax required return of 10%…” I would say below average and not think twice. If you require 10% return on portfolio, the ability is below average and the investor requires education about risk v return and reducing expenses. This scenario is the most complex because you can justify either way. If I recall, the 2006 individual IPS question was about a retired soccer player who had a lot of money (tens of millions) but his expenses were like $2MM a year. I believe his ability was considered below average. I can rummage through my old exams to find it.

The more time I spend on this IPS section, I am getting a funny feeling that I would be better off spending on the PM section. AM is becomeing too subjective

We are all Below Average by spending time on this forum.

or *in this forum.

If you bomb on IPS you will fail the exam it`s that important. This is the FSA of Level 2. Best way to differentiate is to remember: 1) ability is ALWAYS factual, objective 2) willingness is past experience, etc = the subjective stuff ALWAYS go with the lower of willingness and ability. Even if ability is above average and willingness is below average, the risk is below average.

I find the ability part as subjective if not more subjective than the willingness part. Willingness is usually easy to tell from the statements of the client.

even i feel that willingness is easy to spot but ability becomes subjective. also, does situational profiling affect ability or willingness?

darlia Wrote: ------------------------------------------------------- > > ALWAYS go with the lower of willingness and > ability. Even if ability is above average and > willingness is below average, the risk is below > average. Use to think the same too, that is take the lower of the two. But in the CFA text, there are situations when that it not so, but rather an ‘average’ of ability and willingness is taken as the overall risk tolerance. See the Inger family case study on page 128 of Book 2. Ability is ‘above average’, willingness is ‘below average’ and overall risk tolerance is ‘average’.

i know that is what the text says but the exam questions have not. You are not goign to force your client to go into a higher risk tolerance. You have to honour your client`s wishes.

jem Wrote: ------------------------------------------------------- > darlia Wrote: > -------------------------------------------------- > ----- > > > > > ALWAYS go with the lower of willingness and > > ability. Even if ability is above average and > > willingness is below average, the risk is below > > average. > > Use to think the same too, that is take the lower > of the two. But in the CFA text, there are > situations when that it not so, but rather an > ‘average’ of ability and willingness is taken as > the overall risk tolerance. See the Inger family > case study on page 128 of Book 2. Ability is > ‘above average’, willingness is ‘below average’ > and overall risk tolerance is ‘average’. Schweser also says this in Pratice Exams vol. 2. If ability is above-average and willingness below-average then you can average the two instead of taking the minimum. This is another one of the very confusing contradictions in the curriculum.

i think it’s dangerous as seeing cfai / schweser conflicts as contradictory. if the cfai says something different than schweser it’s probably best to forget that schweser ever said anything.

cookthebooks Wrote: ------------------------------------------------------- > i think it’s dangerous as seeing cfai / schweser > conflicts as contradictory. if the cfai says > something different than schweser it’s probably > best to forget that schweser ever said anything. But the CFAI books agree with Schweser on this bit of randomness (see jem’s page reference).

my approach… ability to take risk - default is average! Need to see something specific to suggest otherwise if ability and willingness are contrary then use conservative one, but need to look at the required return and judge if under the conservative approach it is attainable, otherwise strive to inform the investor of this contradiction in return expectations and level of risk aversion.