Ability to take risk
The objective half of risk tolerance, set by time horizon, wealth relative to spending needs and liabilities, and the stability of income. Enthusiasm does nothing to raise it.
Where you will meet it
Ability to take risk appears in 4 learning outcomes on the CFA syllabus. A few of them:
- Explain how defined benefit and defined contribution pension plans work
“A DB plan's investment policy depends on its liabilities: a plan with many retirees has shorter-duration obligations, greater liquidity needs and usually a lower ability to take risk.”
- Justify the ties between a person's human and financial capital and their return and risk targets, objectives and constraints
“A high ratio of human to financial capital increases ability to take risk; a large, fixed spending need relative to financial capital reduces it.”
- Tell apart an investor's return objectives and their tolerance for risk
“Risk tolerance has two distinct components that are frequently confused: the ability to take risk, which is objective and follows from wealth, time horizon and the importance of the goal, and the willingness to take risk, which is psychological.”
- Discuss how private clients differ from institutional ones and draft a suitable investment policy statement for a private client
“An investment policy statement for an individual sets out background and goals, return objective, willingness and ability to take risk, time horizon, liquidity, tax, legal and regulatory constraints, and unique circumstances such as concentrated holdings, then the strategic allocation, rebalancing and review.”
See also
Practise it
Practise ability to take risk until it is automatic: questions that explain every wrong option.
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