Risk tolerance refers to the degree of uncertainty an investor is willing to accept in pursuit of investment returns. Understanding a client's risk tolerance is crucial for investment advisors to create a suitable investment plan that aligns with the client's financial goals and risk appetite.
Which of the following best describes risk tolerance?
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Correct!
Select an option above to see an explanation here.
A) This describes risk capacity, not risk tolerance. B) Risk tolerance is the degree of uncertainty an investor is willing to accept in pursuit of investment returns. C) This describes risk aversion, not risk tolerance. D) This describes investment horizon, not risk tolerance.
Which type of investor is most likely to have a high risk tolerance?
A) A conservative investor has low risk tolerance and prefers safer investments. B) A moderate investor has a balanced risk tolerance, seeking a mix of growth and safety. C) An aggressive investor has a high risk tolerance and is willing to take on more risk for higher returns. D) A risk-averse investor prefers to avoid risk and choose safer investments.
In the late 1990s, many investors had a high risk tolerance and invested heavily in technology stocks, leading to the dot-com bubble. When the bubble burst, those with lower risk tolerance did not experience the market crash with the same severity.
What is the difference between risk tolerance and risk capacity?
A) This confuses risk tolerance with risk aversion and risk capacity with risk-seeking. B) This reverses the definitions of risk tolerance and risk capacity. C) Risk tolerance is the degree of uncertainty an investor is willing to accept, while risk capacity is the amount of risk they can afford based on their financial situation. D) There is a difference between risk tolerance and risk capacity.
A young professional with a stable job and no dependents may have a higher risk tolerance and invest in growth stocks or start-ups, while a retired individual relying on their investments for income may have a lower risk tolerance and invest in bonds or dividend-paying stocks.
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Example Series 65 Example Practice Question
- *Risk Tolerance*: The level of risk an investor is willing to accept in their investment portfolio. It is influenced by factors such as age, income, financial goals, and investment experience. - *Suitability of Investment Recommendation*: The process of ensuring that an investment recommendation is appropriate for a client's risk tolerance, financial situation, and investment objectives.
- *Risk Tolerance Example*: An investor with a high risk tolerance may be comfortable investing in stocks with higher volatility, while an investor with a low risk tolerance may prefer more stable investments like bonds or money market funds. - *Suitability of Investment Recommendation Example*: A financial advisor recommends a portfolio of high-yield bonds to a client who has a low risk tolerance and is nearing retirement. This recommendation may not be suitable for the client due to the higher risk associated with high-yield bonds.