All of the following affect an investor’s risk tolerance EXCEPT: A) tax bracket. B) family situation. C) years of experience with investing in the markets. __________________ I selected C. Correct answer is A. Explanation: Tax concerns play an important role in investment planning. However, these constitute an investment constraint, not an investment objective (i.e. risk tolerance). __________________ I was thinking: in terms of utility curves, tax brackets influence risk aversion (tolerance) by reducing the utility of a payoff when compared against a loss. A risk neutral person who is in the middle of their tax bracket may be indifferent between a gain of a dollar and a loss of a dollar. But that same risk neutral person who is right on the border of a tax bracket would value the lost dollar (at the lower rate) more highly than the gained dollar (at the higher tax rate), and choose to avoid the gamble. As for why C is more appropriate, haven’t we been drilled to think that risk tolerance should have nothing to do with investment experience? That a CFA charterholder representing an unsophisticated investor should try to determine the unsophisticaed investor’s true risk tolerance and manage to it?
Remember LLTTUU Liquidity, Legal, Tax, Time, Unusual/Unique This is the IPS - Risk is a separate measure.
Yes, ditchdigger2CFA is right. LLTTUU affect the investment plan but not really the willingness to take risk. A person might be more risk tolerated because he or she lies in the middle of the tax bracket. In other way, he or she might be young, single, low income etc.
I guess I didn’t need to make a big deal about this one. All I meant is that tax brackets do affect risk tolerance. Someone whose additional income would put them into a 100% tax bracket receives 0 utility from income. They will be completely risk averse, unwilling to risk any amount to gain an additional dollar. That additional dollar doesn’t help them and they still risk losing the last dollar. This is an extreme example to illustrate that even a slight change in tax bracket will influence their willingness to risk a dollar for 1.x dollars. Maybe I don’t understand how this fits into the investment planning section. For example, how long a person has invested in the markets should influence their perception of risk or ability to calculate risk. But it shouldn’t influence their willingness to risk a dollar for 1.x dollars.