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.

mik82

deriv108 Wrote:
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> To make life easier, I use STL to determine the
> ability to take risk.
>
> Size: relatively large portfolio
> Time Horizon: longer time horizon.
> Liquidity: less liquidity needs.

I think there are other considerations too, like having kids or supporting a sick relative.

NO EXCUSES

susana

Determining the ability to take risk for a pension fund is so much easier as they will provide the data for the specific company vs the industry average. If there is such a systematic approach for the individual investor, this area will not be so vague and subjective. I just could not understand why there is no where in the text that mentions what is roughly the average time horizon and the average required return (or liquidity need) for an individual investor portfolio. If there is an "average" starting point like in the case of the pension fund, this process will be much clearer.

liangfeng

Can those things be quantified at all?

lcai

Since the constraints pretty much define the ability to take risk, I think it would be helpful if we can come up with a way to define these "default" constraints.
Time horizon: What is the "average" time horizon?
Liquidity: What is the "average" liquidity need?

I remember that it is mentioned in the Schweser video that the default liquidity requirement is something like 4-6% of the portfolio size (ignoring inflation effect). I am not too clear if this only include the living expenses that needs to be generated from the portfolio, or if it also includes other things such as planned donation. If someone can clearly define what is the "average" metrics for these constraints, maybe the process will become more methodical.

skycfa

Per p116 vol 2, an Above Average Ability is related to "modest goals" relative to the portfolio, long time horizon (consider Stage of Life of individual - foundation = above; distribution = below), and ability to add to the portfolio (has a job or upcoming inheritance that might help pad the portfolio = above).

Zestt

To make life easier, I use STL to determine the ability to take risk.

Size: relatively large portfolio
Time Horizon: longer time horizon.
Liquidity: less liquidity needs.

infinitybenzo

cookthebooks Wrote:
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> i think it's dangerous as seeing cfai / schweser
> conflicts as contradictory. if the cfai says
> something different than schweser it's probably
> best to forget that schweser ever said anything.


But the CFAI books agree with Schweser on this bit of randomness (see jem's page reference).

thommo77

jem Wrote:
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> darlia Wrote:
> --------------------------------------------------
> -----
>
> >
> > 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.
>
> Use to think the same too, that is take the lower
> of the two. But in the CFA text, there are
> situations when that it not so, but rather an
> 'average' of ability and willingness is taken as
> the overall risk tolerance. See the Inger family
> case study on page 128 of Book 2. Ability is
> 'above average', willingness is 'below average'
> and overall risk tolerance is 'average'.


Schweser also says this in Pratice Exams vol. 2. If ability is above-average and willingness below-average then you can average the two instead of taking the minimum.

This is another one of the very confusing contradictions in the curriculum.

Darien

i think it's dangerous as seeing cfai / schweser conflicts as contradictory. if the cfai says something different than schweser it's probably best to forget that schweser ever said anything.