I am still confused with what constitutes above Average, average and below average. Am I the only one feeling its really vague? Are dr indicators or criteria to help which category the risk falls in?
You have to assess the persons financial situation as well as their behavioral/psychological situation.
- Willingness (think: is this person “willing” to deal with volatilty or risk; will they lose sleep over losing any amount of money, or do they not even care because their investments “are for 20yrs from now” according to them). Willingness tends to deal more with behavioral aspects of the person’s situation - you will find in the vignette or description a few keywords to help you (i.e. “I cannot stomach losing any amount of money”)
-Below average = they are conservative, low risk tolerance
-Average = they are middle of the road, have no real thoughts or feelings positive or negative toward risk.
-Above average = they aren’t concerned too much with volatility
- Ability (think: can this person FINANCIALLY afford to take risk, are they “able” to deal with volatility). one very important trick to remember in asnwering this part, as some of the CFAI questions tend to deal with this part directly: is the client able to adjust anything with their financial situation (i.e. can they save more, spend less, etc)? if so, this increases their ABILITY to take risk. if a retiree has $500k in assets, NEEDS to live off of $100k/yr to survive, he/she has a LOW ability to take risk. if someone has $1mil, only spends $50k/yr, and has a $40k/pension for income, they have a HIGH ability (above average) ability to take risk. (in other words, market volatility will not significantly impact their financial situation )
-Below avg = client cannot FINANCIALLY take risk, needs to be conservative. cannot afford, for example, a 30% drop in the mkt
-Average = on test day, this is not likely. most clients, per questions, are either below or above average.
- Above Avg = client can FINANCIALLY deal with the mkt ups and downs. they have low net income needs vs their investable assets. they can easily adjust any of the inputs: save more, spend less.
hope this helps!!
Also, just to add to this, sometimes the client will have contradicting items for willingness to take on risk. The client may state that they do not want any investment losses whatsoever, indicating a low willingness. The same cleint may have started their own business in the past, indicating high willingingness. In this case, these actions offset eachother and the client would have an average willingness to take on risk.
trap i would disagree with that. in that instance you woulnd’t necessarily want to average them out or have the two negate each other; rather, you should take the lesser/more conservative risk tolerance of the two. in that instance, they would have a below average tolerance for risk (especially with the statement of not wanting investment losses at all).
hmm, that is a good point. I thought I came across a question in a schewer mock that basically offset them against each other but the more I think about your latest comment, the more I think you are right. It might be better to go with the more conservative approach.
Bump. I just want to get this straight.
if client ability = above avg, but willingness = below. Overall, willingness wins right?
if client ability = below avg, but willingness = above. Overall, ability wins?
I’ve seen in some questions if one is above-average and the other below, overall it is average. However, if you have, say, below-average willingness and average ability, you take the more consrevative option.
^Sorry, but your first sentence is not accurate. Even if the client has above-average ability, but below-average willingness, this does not balance out to “average”. You always have to choose the lesser of the two.
(If the client happened to have above-average ability but a lesser willingness, then the advisor needs to educate the client on how/why more risk should be taken; conversely, if the client’s ability is less than average but willingness is above average, then the advisor needs to educate the client on how/why less risk should be taken.)