Using Equity Rate (Er) To Guide Conversations

Factors to Consider when Assessing Equity Rate

Average Equity Rate scores depend on a variety of factors**.** Understanding the correlation between these factors and your clients’ equity exposure will help you determine if the given Equity Rate is appropriate or not.

Investment Time Horizon: shorter = Lower Er

Risk Capacity: Higher Capacity = Higher Er

Risk Tolerance: Higher Tolerance = Higher Er

While a client’s investment time horizon can be relatively easy to obtain, determining their risk capacity and risk tolerance proves to be more difficult. Volumes have been written on these two topics, and we will present very briefly a starting point for determining a client’s risk tolerance and risk capacity.

Determining Risk Capacity

A client’s risk capacity can be defined as their actual, functional ability to take on risk. While investment time horizon is the primary determinant of their risk capacity, these factors will also influence it:

Time Horizon: Shorter = Lower RC

Age: Older = Lower RC

Career Stage: Early = Higher Rc

Current liquidity: High = Higher RC

Cash flow: Larger = Higher RC

Debt levels: Higher = Lower RC

Determining Risk Tolerance

A client’s risk tolerance can be defined as how much risk they are comfortable taking. While their risk capacity may influence their risk tolerance, these should not be conflated.

Questions to guide conversations

While many services exist which aid advisors on determining a client’s risk tolerance, you should consider the following as you identify their risk tolerance:

  • Sending the client a risk tolerance questionnaire.
  • The client’s past experiences with investing
  • How the client feels about volatility
  • Can the client stick with their investment plan?
  • Are there recent life events that may influence their risk tolerance?

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