CHAPTER 5

DATA GATHERING AND ANALYSIS

Garbage in, garbage out.

—Unknown

In order to establish an investment policy for a client, the wealth manager must have a clear understanding of the client’s level of risk tolerance and investment goals/objectives. In combination, this data will enable the wealth manager to design an asset allocation that is intended to provide sufficient return to meet the client’s objectives while respecting the client’s level of risk tolerance—enabling the client to sleep at night. This chapter discusses methods of measuring a client’s level of risk tolerance and computing the capital needed to meet client objectives.

MEASURING RISK TOLERANCE

Risk tolerance is one of the most important factors in portfolio design. Unfortunately, it is also the most difficult to evaluate. The difficulty often begins with a fuzzy definition of risk tolerance in the minds of the wealth manager and the client. Even worse, these fuzzy definitions may differ between client and wealth manager. Consequently, the first step is to define the concept in terms that are clear and consistent for both the client and the wealth manager. We propose the following discussion with your clients:

Mr. and Mrs. Client, in order to help design a portfolio allocation that balances your need for returns to achieve your goals and your risk tolerance, we need for you to understand what we mean by “risk tolerance.” We all know that investment markets have good periods, but they also have bad periods ...

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