ok- most of the time i have found this fairly straight forward. but what if a guy has 10mm, no living expenses from portfolio, no bequest (ie. ability is way above average) however, guy is extremely risk averse and doesn’t want to lose more than 2% or something = below average willingness is overall tolerance the average of the two—ie. average? in Schweser, in the notes it says ALWAYS use the willingness if below ability (which is always how i’ve thought about it). however, in the practice exams they say that it can be the average of the two with recommended counseling? Thanks!
Always go with the more carefull and restict answere…be on the conservative side when in doubt…
Go with the most conservative, unless it seriously jeopardizes the ability to meet required returns (in which case you should suggest investor education to reconcile difference, or a rethinking of retirement spending requirements). I’ve seen Schweser give some messed up and inconsistent answers in Q-bank regarding risk objectives. I’d suggest paying closer attention to CFAI’s reasoning on past exam IPS questions.
If the person is extremely wealthy, thus having a very high ability to take risk (as in this case) and is extremely risk averse, thus having a very low willingness to take risk (as in this case), the overall tolerance is average. This is the only scenario in which this is appropriate. Otherwise, go with whichever is more conservative, ability or willingness.
i agree with hezagenius. just make sure to make a case for averaging the two.
SPOILER I recommend looking at the risk tolerance question on the IPS for the past three years of the real exams. Notice a pattern?
I will also add this - time horizon tends to trump a lot of things. If the person has a long time horizon, their ability is usually considered above-average even if they aren’t very wealthy.
sometimes a client who obviously is very wealthy but for some reason very risk averse can be educated and his fears explored…at the end of the meeting he may change his risk tolerance!
thanks guys. haven’t made it to CFAI exams, but that will come shortly. i just don’t want to get hosed on risk questions on this exam, because these are easy points.
hezagenius Wrote: ------------------------------------------------------- > I will also add this - time horizon tends to trump > a lot of things. If the person has a long time > horizon, their ability is usually considered > above-average even if they aren’t very wealthy. Not always. Young, poor investors have below average tolerance for risk based on their limited financial capital.
KRochelli Wrote: ------------------------------------------------------- > thanks guys. haven’t made it to CFAI exams, but > that will come shortly. i just don’t want to get > hosed on risk questions on this exam, because > these are easy points. Actually, the risk question is usually more nebulous than the return question. The risk questions require you to dig into the case a little and then make a judgment call. The return questions are relatively straightforward once you have all the data.
hezagenius Wrote: ------------------------------------------------------- > I will also add this - time horizon tends to trump > a lot of things. If the person has a long time > horizon, their ability is usually considered > above-average even if they aren’t very wealthy. I think it’s *wealth* that actually trumps *time horizon*. For someone who is massively rich but very old, for example, his risk tolerance will be high compared to a young, but poor chump.
I agree with Dwight and lolly: wealth trumps time horizon.
lolly Wrote: ------------------------------------------------------- > I think it’s *wealth* that actually trumps *time > horizon*. For someone who is massively rich but > very old, for example, his risk tolerance will be > high compared to a young, but poor chump. Obviously wealth can trump time horizon. If a person has a $1B portfolio, their ability is above-average. Unfortunately, CFAI isn’t going to toss you a meatball like that on the exam. Unless the portfolio is supplying a large portion of annual income for bills, etc., then if a person has a long time horizon, their ability is above-average. Look at last year’s example: the family needed almost 10% in annual return (relatively high) and their ability was above-average. They weren’t extremely wealthy but they had a long time horizon.
hezagenius Wrote: ------------------------------------------------------- > Look at last year’s example: the > family needed almost 10% in annual return > (relatively high) and their ability was > above-average. They weren’t extremely wealthy but > they had a long time horizon. Yes, but they also expected a huge amount of funds down the road (1/2 of the trust in 10 years + a substantial inheritance from parents).
Here’s a classic Schweser contradiction…gotta be below average here. Not to mention they give a range, which is a no-no (e.g., below to avg): The Swathman’s financial situation indicates an above-average ability to incur risk. In contrast, their statements reflect an average to below-average willingness to take risk. The size of their assets in the context of their age (time horizon), suggests that they are unlikely to exhaust their savings during retirement. In sum, the data indicate an average to above-average risk profile. (Study Session 4, LOS 14.a)