What exactly is Risk tolerance in context of IPS and wealth management questions. How is it related to ability and willingness to take risk ? I get confused whether to mention factors thar effect willingness or ability when questions ask for risk tolerance ?
Risk tolerance is the combination of willingness and ability to take risk.
If they ask you to determine an investor’s risk tolerance, you need to assess their willingness to take risk (below average, average, or above average) and their ability to take risk (below average, average, or above average), then put them together for the overall risk tolerance.
When you combine them, historically CFA Institute has used the more conservative of willingness and ability as the overall risk tolerance. However, recently I have seen some examples where one (of willingness and ability) is above average and the other is below average, and their conclusion for overall risk tolerance is average.
Thanks a lot !
My pleasure.
I always structure my risk tolerance questions as follow:
Ability: below/avg/above
Willingness: below/avg/above
Overall: below/avg/above
That’s the way to do it.