Ability vs Willingness

In the notes: If ability and willingness are in conflict it says to ‘design portfolios consistent with the WILLINGNESS to assume risk. The only exception is when the willingness to assume risk jeopardizes the ability to achieve portfolio objectives.’ Then from the 2006 CFA question: You have a client that has a high willingness to accept risk (speedboats, real estate speculation), but his current ability to accept risk is diminished because of total assets and current income/spending situation. Wouldn’t it make sense to default to the willingness and say that the clients risk tolerance is above average? The answer key says that ‘the clients risk tolerance is below average. When and investor’s willingness to accept risk exceeds the ability to do so, ability prudently places a limit on the amount of risk the investor should assume.’ Can anyone help? Is this just because high risk will jeopardize the ability to achieve the objectives? Seems dicey…

The whole topic is dicey and not well explained. It seems like a lot of their scenarios are in a gray area, and you can make arguments for either answer.

Think about it this way. Suppose I want to be an NBA player, but I have no skill. That means I don’t have the ability to be an NBA player…but I REALLY want to be an NBA player. It just doesn’t matter because I suck at basketball. Defaulting to willingness will do nothing for me. "If ability and willingness are in conflict it says to ‘design portfolios consistent with the WILLINGNESS to assume risk. The only exception is when the willingness to assume risk jeopardizes the ability to achieve portfolio objectives.’ " So I would say: if Willingness is less than ability go with willingness if abillity is less than willingness go with ability

^^ I would go with the most conservative measure of risk as mwvt9 stated.

mwvt9 Wrote: > So I would say: > if Willingness is less than ability go with > willingness > if abillity is less than willingness go with > ability my only issue with this is i remember reading that if a client has the ability but not the willingness and he has higher return objectives you are supposed to teach him about what his ability is or something like that…

In the real world there is no right answer. If the client has the ability to take risk, but not the willingness and he NEEDS high risk (high return) to meet long term objectives the client has only two choices: 1. Lower the goals in the future and sleep comfortably at night with lower risk 2. Keep the goals the same and go to a risk level that you weren’t willing to go to at first (but had the ability) I can tell you from experience that most people overestimate their risk tolerance. So strategy 2 is inherently dangerous unless they REALLY understand what they are dealing with. Institutional clients may be different (I am dealing with individuals).