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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Risk Profiling for Investors

Mr. Arvind Menon, 58, is a government school principal retiring in two years. He scores high on a risk tolerance questionnaire because he enjoys equity investing. His only retirement corpus is Rs 60 lakh, and he needs most of it to fund expenses after retirement. What is the most appropriate way for the adviser to set his risk profile?

The adviser should base the profile on the lower of risk tolerance and risk capacity. Mr. Menon's short horizon and heavy reliance on a single corpus limit his capacity, so capacity governs despite his high tolerance score. Following tolerance alone would expose essential retirement funds to avoidable loss.

  1. AUse the higher tolerance score because the client's own preference should always prevail
  2. BAverage the tolerance score and the required-return figure to arrive at the profile
  3. CBase the profile on the lower of risk tolerance and risk capacity, which here is capacityCorrect
  4. DIgnore the questionnaire and assign the most aggressive profile since he is experienced

Explanation

Where tolerance and capacity conflict, the prudent approach is to adopt the lower of the two. Here his short horizon and dependence on the corpus limit capacity, so capacity governs. Using the high tolerance score would expose essential funds to loss.

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