Overall risk tolerance

CFA Level III
#1

Average of willingness and ability or should you take the lower of the two?

#2

Curriculum states that the lower of the two.

Client could have above-average ability (e.g. large asset base, no debt, long time horizon, etc), but his willingness may be below-average due to something like poor past experiences. So, you would mark down below-average risk tolerance.

#3

LOWER!

#4

I thought it would be the lower of the two as well. However, if you look at some of the sample IPS statements (ex Ingers on pg 190 of CFAI books) it seems to average the two. In that example, ability is above average, willingness is below average and the overall risk tolerance is average (or moderate).

Also, on pg 194, it does not take the lower and gives a pretty squishy answer of average to below-average.

Mr Z, where do you see it mentioned explicitly in the curriculum?

#5

I can’t reference a specific page number in the text. But, from the questions that I’ve answered (mocks and EOC), the explanations normally state the lower of the two.

However, I do see your point on the Inger’s example of the CFAI averaging the two. Hopefully on the actual exam, the question will be something like ability is above-average and willingness is average, so the answer would be average.

#6

just read over this topic this weekend in Schweser, i think they state in Book 5 to NEVER go above the willingness of the client. so if ability is above average but willingness is below average, overall risk tolerance should be below average. I would pick the lower of the two or you can also say average to below average :slight_smile:

#7

Now after reading some rules of thumb in SCH book 1 Exam 1, I have a new view.

Here few observations:

  1. Take the average of the two.
  • If ability is above average but willingness is below average. Overall is average
  1. Whenever there is a difference between willingness & ability, take the average of the two & suggest investor education to reconcile difference
  • Till now, I have understood as whenever is willingness is higher than the ability than only suggest to reconcile
  1. Portfolio size of greater than $10 mil is considered large & liquidity req of 2-3% relative to portfolio is considered small.

Wondering whether these should be appropriate from the exam point of view…

#8

based on the CFAI book, above average Ability and below average Willingness would equate to below average risk tolerance but the book add that since assets are so large Willingness should go up to average and thus risk tolerance should be average.

So what risk tolerance would you suggest for the following scenarios?

A = Ability, W = Willingness

  1. A - Above Average & W - Below Average = Average

  2. A - Below Average & W - Above Average = Below Average?

  3. A - Average & W - Below Average = Below Average? 4) A - Average & W - Above Average = Average?