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

Mr. Iyer, aged 38, has a stable government job, no debt, a large emergency fund and a long horizon, so his risk capacity is high. In the questionnaire, however, he says he would sell everything if his portfolio fell 10% in a month. What should the adviser do when setting his risk profile?

The adviser should generally base the risk level on the lower of risk tolerance and risk capacity, and discuss the mismatch with the client. A client who would panic-sell at small losses is unsuited to an aggressive allocation even if financially able to bear losses.

  1. AUse the high risk capacity and recommend an aggressive allocation
  2. BAverage the two and recommend exactly a 50:50 equity-debt split in every case
  3. CIgnore the questionnaire because behaviour cannot be measured
  4. DGenerally base the recommended risk level on the lower of tolerance and capacity, and discuss the mismatch with the clientCorrect

Explanation

When willingness and ability differ, the prudent approach is to adopt the lower of the two, since a client who panics will likely lock in losses. The mismatch should be discussed and documented, possibly with education to raise tolerance. Using capacity alone ignores likely behaviour, and a fixed average is not a standard rule.

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