IPS: Ability to take risk average, defining, ability

Howd

Hi,
Is there a systematic way in defining the client's ability to take risk? I find this area very frustrating as there is no place in the text that define the "average". Thanks for your help.

justin88

No

NO EXCUSES

Valores

IN a real world, there is a systematic way of defining ability and willing to take risk.

In the CFA world, it is based on 'gut' feeling..

mar350

If person is young, then ability is usually above average (mention human capital if you can, CFAI loves this term)
If asset base is very large, above average
If there is no need to start withdrawing from portfolio right away, above average
If retired, below average
If portfolio is sole source of income, below average (unless portfolio size is really, really big relative to expenses)

Pray you get a young person or couple (above average) or a super wealthy person (above average). Above average tolerance is usually clear cut. Average or below average is tougher to gauge. If you get a retired person and can't decide what their tolerance is, go with below average.

canadiananalyst

One thing I have notice based on EOC questions, even though they have large asset base 20x expenses but if their income is less than expenses and around age 50, inspite of long term and good asset base, CFA defines as average risk

pennyless

If I saw this on a test:

"...you have say $50 mm in assets and annual expenditures of $3.5 mm, with inflation of 3%. That is a nominal after tax required return of 10%..."

I would say below average and not think twice.

If you require 10% return on portfolio, the ability is below average and the investor requires education about risk v return and reducing expenses. This scenario is the most complex because you can justify either way.

If I recall, the 2006 individual IPS question was about a retired soccer player who had a lot of money (tens of millions) but his expenses were like $2MM a year. I believe his ability was considered below average. I can rummage through my old exams to find it.

IAmNeil

We are all Below Average by spending time on this forum.

Unforseen

or *in this forum.

Chuckrox

If you bomb on IPS you will fail the exam it`s that important. This is the FSA of Level 2. Best way to differentiate is to remember:

1) ability is ALWAYS factual, objective
2) willingness is past experience, etc = the subjective stuff

ALWAYS go with the lower of willingness and ability. Even if ability is above average and willingness is below average, the risk is below average.

liangfeng

even i feel that willingness is easy to spot but ability becomes subjective.

also, does situational profiling affect ability or willingness?