High Ability and Low Willingness - net effect on risk tolerance?

Above Average,

Average

Below Average

And why?

Morning exam related to IPS designed to be less confusing. When related to risk tolerance, either above or below…

If the client express above average willingness and the facts suggest that he has below average liability to take the risk, then most of the case, the risk tolerance would be BELOW average.

Rex, typically it is best to go with the lower or willingness or ability, unless there is a case-specific item that suggests otherwise. Given your example here, high ability, but low willingness to take risk, the overall risk objective will be below average, all else equal.

Edit: Why? Because if the client has the ability (i.e. financial wealth) to afford a lower risk, thus lower return, profile, then it is okay to suggest a sub-optimal portfolio because it does not significantly affect the overall goal - don’t run out of money.

OK. So willingness dominates ability

Like let’s say:

He is 30 with Long Time horizon, no dependents, owns his home debt free, has a large asset base.

BUT he invests in treasuries and equity markets make him anxious.

Despite the overwhelming number of positive ability features he is still below average?

I trust that you meant _ above average _ ability and _ below average _ willingness, not high and low.

Rule #1: make it as easy as possible for the grader to give you full marks. Using _ their _ words is always a good idea.

Historically, CFA Institute’s position has been that for overall risk tolerance you use the more conservative of ability and willingness; here, that would argue for a below average risk tolerance.

However, I’ve seen examples from CFA Institute in which one of willingness and ability was above average and the other was below average, and their conclusion was average risk tolerance.

Here’s my rule:

  • When one is above average and the other below average, conclude average
  • With any other combination, conclude the more conservative
  • Write your conclusion, move on to the next question, don’t look back

Note: willingness doesn’t trump ability.

Thanks Bill. Much appreciated.

You’re quite welcome.