A client, age 45, states during IPS review that she has low risk tolerance and wants to avoid equity volatility. She also states she needs her $200,000 portfolio to grow to $700,000 in 20 years to fund retirement, with no additional contributions planned. The portfolio manager calculates the required annual compound return and finds it is approximately 6.5%. A conservative fixed-income-heavy allocation is expected to return only about 4% annually. What should the portfolio manager do?
- ABlend the client's conservative preferences with a more aggressive model portfolio used for other clients without informing her
- BMaintain the conservative allocation and discuss with the client that the return objective is inconsistent with her stated risk tolerance
- CIncrease the equity allocation substantially to meet the 6.5% return target, since return objectives take priority over stated risk tolerance
- DIgnore the return objective, since Standard III(C) only requires the manager to follow the client's stated risk tolerance
Show answer & explanationAnswer & explanation
Correct answer: B. Maintain the conservative allocation and discuss with the client that the return objective is inconsistent with her stated risk tolerance
Required return: (700,000/200,000)^(1/20) − 1 = 3.5^(0.05) − 1 ≈ 6.5%. Since a 4% conservative return cannot meet this goal, Standard III(C), Suitability, requires the manager to reconcile the conflict between the client's risk tolerance and return objective through direct discussion rather than unilaterally overriding either one.
Why the other options are wrong
- A. Using another client's model without disclosure violates suitability and fair dealing obligations.
- C. Unilaterally overriding the client's stated risk tolerance without discussion violates suitability principles.
- D. Suitability requires considering both risk tolerance AND return objectives, not just one factor.
Suitability (III(C))
Members must consider a client's full IPS, including risk tolerance, return objectives, time horizon, and constraints, and reconcile any conflicts through client communication before implementing a strategy.
- Required return formula: (FV/PV)^(1/n) − 1
- Conflicts between risk tolerance and return goals must be discussed with the client
- Suitability decisions must reference the client's total IPS, not a single factor
Memory trick: "When goals and comfort collide, talk before you decide."