Zidane is a young individual in accumulation stage … who has long time horizon but after his marraige has taken several loans on EMI… so his curent salary is not enough to provide for the living expenses and the loan EMI and portfolio income is required to meet the shortfall… What would be the risk tolerance ? Average or above average?? My answer is “average”… am I correct ??? Though very long time horizon would suggest abv avg risk ability… but the client is dependant on the portfolio to meet his shortfall suggests only average risk tolerance…
I’d say below-average to average, but leaning more toward below-average, the client can’t allow to take significant losses at least at this moment (low ability); he is to dependent on portfolio income for living expenses, otherwise he can go hungry. After, the situation will stabilize and loan will be repaid, his ability to take risk will increase and so will his risk tolerance.
Correct me if I’m wrong, but I believe the level of wealth trumps the individual’s time horizon…thus, in this situation, the client may only be able to take a below-average amount of risk.
The exam question would ask for circling one of the options …Abv avg, Average, Below average… Mentioning below avg to average wont help… think of a individual aged 30… with a housing EMI and hence the salary shortfall… he has around 45-50 years time horizon… how to mark below average ?? Time horizon is the greatest determinant of risk tolerance and other factors also need to be given good weight… so I think it has to be Average … Writing Below average means ignoring the long time horzon…
I would say Below Average. He has several loans which require payments or else he’ll say lose his house, his current salary is not enough to provide for living expenses so he depends on portfolio income to meet the shortfall…this man does not have any ability to take risk b/c like I said if he has a bad month or two he migth lose his car then his house then his dog then his children to slavery…
Time horizon does not matter if you you cannot put food on the table. Frankly in this case his time horizon is determined by his liquidity needs, which are monthly.
Think about it this way…BigWilly has a long time horizon say at least another 40-50 years (as long as I dont get hit by the proverbial bus), but BigWilly doesnt have his CFA Charter so he is washing dishes at McDonald’s until he can get a job at Goldman making $1000/month. Now BigWilly has a $500/month BMW payment to make b/c he is living on future income, and $1000/month payment on other (rent, food, utilities,etc). Luckily BigWilly’s Aunt, AuntWilly, died and left him some dough that provides $500/month in income. So with this account and his job he is just able to meet payments…what’s my risk tolerance??? Below Average…I don’t have much ability to suffer losses or else the Repo man might take my Beemer.
ha ha … good one… but I feel that the shortfall ( Salary - living expenses - EMI) wont be that big as it is for a retired investor whose living is entirely dependant on portfolio… Here salary is very big cushion… so if the shortfall would be say 4-5% then Below average would be too harsh… I would still go with “Average”
His Salary isn’t a cushion b/c it isnt covering all his expenses so he is relying on his portfolio to make up for the shortfall. In other words his income provides 80% of his income needs and his portfolio makes up the remaining 20%. If his income fully covered all his expenses, then yes he would have a higher risk tolerance than he does currently.
average. There is an example in CFAI, exactly the same that states it is average even though there is a signficant shortfall.
CFAI is wrong that’s my answer! I want an Errata unless we don’t have the full details of the case above…
well in ceratain answers CFAI also says that if willingness is below and ability above - overall is average… who knows… it is such a grey area i will rely on my derivatives knowledge to pull me out of this one
I think if you state your case as Below-Average due to the above reasons they will give you full or close to full credit, as long as the guy/gal grading didnt have a case of road rage gettign to the place to grade your paper…
i have got no clue when to mark “average”… below average is usually the case when either the willingness is below average or the client is Completely Screwed up…when atleast few things are positive like time horizon, significicant asset base, modest requirements I am skewed towards average risk tolerance…