Case 029Risk profiling and IPSCore

A client scores aggressive on the risk questionnaire, but most of his portfolio is earmarked for a house purchase in two years. How do you reconcile tolerance, capacity and need, and what allocation does each part get?

The situation

Farhan Qadri, 38, runs a profitable design studio in Bengaluru and has Rs 2.5 crore invested. His questionnaire comes back aggressive: he has held equity through past falls without selling and says he wants growth.

In the same meeting he mentions that Rs 2 crore of the portfolio is for a house he plans to buy in about two years; the seller has agreed a price and he intends to pay mostly in cash. The remaining Rs 50 lakh has no planned use. His studio income comfortably covers his living costs.

Your task

Reconcile his risk tolerance, risk capacity and need for return. Set an allocation for each part of the money and for the portfolio as a whole.

Quick check

What equity share should the house money carry?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Split the portfolio by horizon: the Rs 2 crore house money goes to short debt with no equity, and the Rs 50 lakh growth money goes 90% equity. His tolerance is high, but capacity is low for money with a two-year date, and capacity wins. The portfolio ends at about 18% equity. The aggressive score is honoured where it applies, on money that can wait.

Step 1Why can a calm client still have low capacity for risk?

A driver who loves the scenic route should still take the highway when the flight leaves in forty minutes. Risk toleranceHow willing a client is to accept falls in value, measured by attitude and past behaviour. is how a fall feels to the client; risk capacityHow large a fall the plans of a client can absorb without failing, set by time horizon, income and obligations. is whether his plans survive it. Farhan's temperament is not the problem. The problem is the date on Rs 2 crore of his money, which no amount of calm can move.

Step 2How do you apply the three tests to each part?

Score the money, not the man. The house fund has a fixed date two years out, so capacity is low, and it needs no growth because the price is agreed, so need is low too. When capacity is low, it overrules tolerance, and the house money goes into short-term debt and deposits laddered to the purchase date. The Rs 50 lakh has no date and is backed by his income, so capacity is high, and his tolerance applies in full.

Split the money by when it is needed, then score each partHouse money: Rs 2 crore, due in 2 yearsTolerancehighCapacitylowNeedlowAllocation: 0% equityshort debt and deposits laddered to the dateGrowth money: Rs 50 lakh, no dateTolerancehighCapacityhighNeedmoderateAllocation: 90% equitythe questionnaire result applies hereWhole portfolio: 18% equity, against 80% if the score were applied to all Rs 2.5 crore
Scored separately, the Rs 2 crore house fund has high tolerance but low capacity and low need, so it holds no equity, while the Rs 50 lakh growth fund scores high on both and holds 90% equity, leaving the whole portfolio at 18% equity.
Step 3What would the questionnaire answer alone have cost him?

Run the stress case the client needs to see. At 80% equity across the whole portfolio, a 30% fall a year before the purchase takes Rs 48.0 lakh from the house money, and falls of that size have in the past taken longer than two years to recover. He would then face a bigger loan or a missed purchase. Split by horizon, the house money loses nothing and the growth money loses Rs 13.5 lakh, which has years to recover.

The same 30% equity fall, before and after splitting, Rs lakhOne aggressive mix: loss on house money-48.0One aggressive mix: loss on growth money-12.0Split: loss on house money0Split: loss on growth money-13.5
In a 30% equity fall, one aggressive mix loses Rs 48.0 lakh of house money; split by horizon, the house money is untouched and the growth money loses Rs 13.5 lakh, a loss that has time on its side.

Write the split into the policy so the house money cannot drift back into equity when markets are rising. The statement should say that the 18% overall figure is an output of two decisions, not a risk level chosen for Farhan. Once the house is bought, the portfolio is Rs 50 lakh of growth money and his profile applies to all of it.

Where candidates lose it

The trap is averaging: calling Farhan moderate and putting 50% equity everywhere. That still exposes the house money to a fall of Rs 30 lakh and still under-invests the money that can wait.

The other miss is treating the questionnaire as the answer. It measures tolerance. Interviewers want to hear capacity and need named separately, and to hear which one wins when they disagree.

What the interviewer asks next

  • The house seller delays by a year. Does the house money's allocation change?
  • Farhan asks to put the house money in an arbitrage fund. What do you check first?
  • How would you record this in the investment policy statement so a future adviser does not undo it?

Company names and figures are illustrative.