Ability to take RIsk - CFAI 2008 - Individual

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cipherap15

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When considering ability to take risk and looking at portfolio size relative to spending needs I understand the higher the ratio, the greater the risk tolerance. Do they have any range of a numerical value that would be considered high or low?
Doing a question and it states the individual has a moderate asset base relative to required cash flows from the portfolio.
From the 995 000 portfolio it requires 55 000 a year to go towards a mortgage. They consider this something that lowers the ability to take risk. I wouldn’t have stated that. I thought it would constitute a moderate to high ability to take risk.
anybody? thanks.
 
Seems odd considering that it’s less than 6% of total portfolio. Did they depend on any additional income from the portfolio to sustain living standards, etc? Were they able to work or were they retired? Seems strange that would have lowered the risk. Perhaps the importance of it being a mortgage played a role?
 
What are the other factors?
I think its either going to be a high tolerance for risk or a low tolerance for risk.
From the point of view, the answer should be obvious.
no mtg -> high tolerance for risk.
yes mtg –> low tolerance for risk.
It should be clear as mud.
 
It;s the 2008 CFAI exam with the Carvalho’s. They give two things that reduce the Ability to take risk
1.. They have moderate asset base relative to required CF’s from the portfolio
2. Ther is no assurance the childrens education will be covered by scholarships
I got the second one. They’re still working and Income covers Expenses which are 120 000. And there’s a mortgage of 55 000. They have stable income. So when looking at portfolio size to spending needs, I only looked at the expenses of 55 000. I’m assuming you would look at the 55 000 regardless of the stability of income anyways. SO, with only the mortgage of 55000, I said it’s high ATTR.
So in the solutions for what lowers ability to take risk ONLY those two were listed. And I dont understadn the first solution.
 
I agree with you. I don’t get it either.
I have been annoyed by quite a few CFAI exam answers so far. Just don’t understand the logic. I don’t think some answers are even convincing, IMO.
 
cipherap15 wrote:
When considering ability to take risk and looking at portfolio size relative to spending needs I understand the higher the ratio, the greater the risk tolerance. Do they have any range of a numerical value that would be considered high or low?
Doing a question and it states the individual has a moderate asset base relative to required cash flows from the portfolio.
From the 995 000 portfolio it requires 55 000 a year to go towards a mortgage. They consider this something that lowers the ability to take risk. I wouldn’t have stated that. I thought it would constitute a moderate to high ability to take risk.
anybody? thanks.
Click to expand...
5.5% is a sizable amount of money.
Consider that 5% is usually a moderate target rate of return, with 7-10% and 2-4% being aggressive and conservative respectively.
The portfolio needs to to earn 5.5% to cover mortgage costs, so that goes out the window every year. In order not to get a volatile prinicpal (and put yourself in a situation where you need to earn 8-9% the following year), your ability to take risk is subdued. Note that high ability to take risk is greatly tied to time and liquidity, because even though you can earn high returns with high risk exposure, this only materializes over the long term, with great fluctuations in between, and you cannot afford that here. This is not obviously explicit, but a crucial point in the IPS topics that you always need to keep in mind.
 
THanks for the replies.
I do get what you’re saying but I’m sticking with the idea that when it comes to ability to take risk, unless I’m completely stuck I’m going to avoid comparing Spending needs with asset base. It seems to the least useful and concrete of the answer. I’m using it as a last resort.
 
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