Risk Tolerance

B is correct. Despite David's high risk CAPACITY (long time horizon, high income, substantial savings, no liquidity needs), his past behavior demonstrates LOW risk WILLINGNESS (panic-sold during volatility, couldn't tolerate temporary losses). Risk tolerance requires using the LOWER of capacity and willingness. A moderate 60/40 portfolio provides growth potential while respecting his psychological comfort level. This prevents future panic-selling that could harm long-term returns.

A violates suitability by recommending based solely on capacity while ignoring demonstrated low willingness. When David experiences the next downturn, he'll likely panic-sell again, turning temporary market declines into permanent losses. C is overly conservative and doesn't utilize any of his high capacity. D incorrectly "averages" the two components - the rule is to use the LOWER, not the average. Risk tolerance is determined by the constraining factor (willingness in this case), not mathematical averaging.

A is correct. Risk tolerance comprises two distinct components: (1) Risk CAPACITY - the financial ability to take risk based on objective factors like time horizon, income stability, net worth, and liquidity needs, and (2) Risk WILLINGNESS - the psychological/emotional comfort with volatility and potential losses, assessed through past behavior, emotional reactions, and stated preferences. Both must be evaluated, and the LOWER of the two determines appropriate recommendations.

B confuses components. While preferences and experience are relevant to assessing risk tolerance, they are not the two formal components. Stated objectives inform willingness, and past history can reveal true willingness vs. stated preferences. C references risk disclosure requirements but not the two components of risk tolerance. Risk awareness relates to suitability (client understanding), but acceptance/disclosures don't determine tolerance level. D describes quantitative risk metrics (standard deviation measures portfolio risk, Sharpe ratio measures risk-adjusted returns), not the client profile components that define individual risk tolerance.

B is correct. While Jennifer has HIGH risk WILLINGNESS (comfortable with volatility, stayed invested during downturns), her risk CAPACITY is reduced by significant near-term liquidity needs ($800,000 needed within 4 years: $600,000 for vacation home in 3 years + $200,000 for college over 4 years). Funds needed within 3-5 years should not be exposed to equity market risk. The appropriate allocation is 60/40 with $800,000 specifically allocated to low-risk, short-term bonds or cash equivalents to meet these obligations. This respects both her willingness (60% stocks is still moderately aggressive) and her capacity constraints (protects near-term needs).

A ignores the critical capacity limitation created by near-term liquidity needs. If markets decline 20-30% right before her daughter's college payments or home purchase, she'd be forced to sell equities at a loss. D is highly unsuitable - 100% stocks with $800,000 in near-term obligations creates unacceptable risk regardless of psychological comfort. C is overly conservative given her demonstrated high willingness and $1.7M that won't be needed for 10+ years. After setting aside funds for near-term needs, her remaining capacity supports moderate-to-aggressive allocation.

C is correct (the EXCEPT answer). Stated preferences and comfort with volatility indicate risk WILLINGNESS (psychological factors), NOT risk CAPACITY (financial ability). This is a common confusion. Willingness is what the client WANTS or feels comfortable with emotionally. Capacity is what the client CAN AFFORD financially.

A indicates high capacity: Long time horizons allow portfolios to recover from temporary downturns, increasing ability to take risk. The 30-year period provides multiple market cycles to ride out volatility. B indicates high capacity: Stable income exceeding expenses means the client won't need to liquidate investments during downturns and can continue contributing regardless of market conditions. D indicates high capacity: Substantial net worth and emergency reserves mean temporary portfolio losses won't threaten financial security or force liquidation at unfavorable times. High net worth also allows absorbing losses that would devastate smaller portfolios.

B is correct. Statements 1, 2, and 4 are accurate.

Statement 1 is TRUE: Marcus has HIGH risk CAPACITY. His $4M net worth with only $50,000 annual withdrawals (1.25% withdrawal rate) provides substantial financial cushion. He can afford temporary losses without threatening his lifestyle, and his low withdrawal rate means he won't be forced to sell during downturns. These are objective financial factors indicating high capacity.

Statement 2 is TRUE: Marcus has LOW risk WILLINGNESS. Despite stating he wants "maximum growth," his BEHAVIOR reveals low psychological tolerance: daily account monitoring, anxiety at 2-3% drops (normal daily volatility), and panic calls during downturns requesting to move to cash. Past behavior during volatility is the most reliable indicator of willingness - actions speak louder than words.

Statement 3 is FALSE: Marcus should NOT receive aggressive recommendations despite high capacity. This violates the fundamental rule that the LOWER of capacity and willingness determines appropriate risk level. Aggressive recommendations would lead to panic-selling during inevitable downturns, converting temporary market declines into permanent losses.

Statement 4 is TRUE: Marcus's appropriate risk tolerance is LOW because willingness (low) is lower than capacity (high). Suitability requires using the constraining factor. Recommending investments beyond his psychological comfort, even if within his financial capacity, would be unsuitable and likely result in harmful panic-selling behavior.