This is something new this year but is posting some contradiction to me. When asked to provide IPS for a young person (with long time horizon but small/negative discretionary wealth), what kind of risk level should we recommend? - sticky
based on the time horizon they can take on above average risk. with negative discretionary wealth they can talk on below average risk. So combining these two factors alone I would be tempted to say the ability to assume risk is average. no hard and fast solution though so i feel your pain. I’m not even confident i’m correct
if a young person currently has small/negative discretionary wealth but with a long time horizon with only the above information - Average risk level. if the person plans to increase his human capital in short term: for short term - below average for long term - above average. if the young man work is related to capital markets: for short term - below average for long term - average.
If you have negative discretionary wealth, I think your ability to take risk is below average, and that trumps the time horizon argument, because the young person will likely need additional liquidity to bring discretionary wealth to at least zero or slightly positive. Under these circumstances, the fact that things will even out over the long term is not reason enough to risk short-term losses. If you have low discretionary wealth, but still positive, I think the time horizon and discretionary issues may balance out to average risk taking ability. Is this a general question or is there an answer quoted somewhere. By the way, what does average risk taking ability mean exactly in terms of portfolio volatility. Are there general guidelines, like 60/40 = average?
Any rule of thumb regarding the level of required return that is considered acceptable for a high-ability to take risk ? ( Is 9% required return too high? )
I would go with conservative (below average risk) for long time horizon, -ve discretionary wealth.
I’m not sure if we are referring to the same thing sticky, but this is what I find contradictory in the level 3 curriculum: Statement 1: A young person is supposed to have a long term horizon and large human capital, therefore ability to take risk is high. Statement 2: Ability to take risk increases with wealth and age, implying that a young person does not have the wealth to take risk and should consider safe investments. Anyone?
Totally agree with dezert. In one chapter, they make a matrix for wealth level and age. In that matrix, wealth trumps age. Any body not wealthy should be conservative regardless of age. In an other chapter, they analyze discretionary wealth with broadly defined concepts of assets and liabilities. Mostly considering the proportion of human capital and financial assets in conjunction with their relation to the liabilities, they come to a conclusion where age mostly trumps wealth (in conventional money sense)
Yeah I struggled with the contradiction CFAI talked about but I would go with time horizon unless you see that young person potentially needing liquidity in the near term or having a job that is tied to equity markets in which case you may recommend real estate, commodities, fixed income and things that are less correlated with his potential earning power. There is no way you would recommend a low risk low return portfolio to a 25 year old regardless if he is not “Wealthy”. Its basically how much he can save and contribute and whether or not he needs the money anytime soon. If he’s planning on making a down payment on a house in a few years then you’d scale back risk, but the general rule is if he has a long time horizon and isn’t risk averse you’d want to recommend a higher allocation to equities and the like.
Could it b multistage case - below average until he builds up some wealth (say for 5 years) and then above average for later years? If you have no discretionary wealth, your liquidity needs are high, which would imply below average ability to take risk.