Case 079Risk profiling and IPSWarm up

Match three clients to three model portfolios, 80/20, 50/50 and 30/70: a 28-year-old saver, a 50-year-old whose child starts college in 3 years, and a 72-year-old living on the portfolio. Justify each match.

The situation

Your desk offers three model portfolios, stated as equity to debt: 80/20, 50/50 and 30/70. Three new clients arrive the same week.

The saver is 28, has Rs 12 lakh invested, adds Rs 30,000 a month from salary and plans no withdrawals for 30 years. The parent is 50 with Rs 1.2 crore; Rs 40 lakh of college fees fall due over years three to six, and he plans to retire at 60. The retiree is 72 with Rs 2 crore, no pension, and draws Rs 8 lakh a year to live on. For the stress test, assume equity can fall 35% in a bad year.

Your task

Which model goes to which client, and what number would you show each of them to justify it?

Quick check

The parent is 50 with a big bill in three years. Is 50/50 too risky for him?

Worked solution

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

30-second answerThe answer to give first

The saver takes 80/20, the parent 50/50 and the retiree 30/70, because horizon and dependence on the portfolio decide the fit. The saver draws nothing for 30 years and a bad year costs less than a year of his savings. The parent's debt half, Rs 60 lakh, covers the Rs 40 lakh of fees. The retiree's Rs 1.4 crore of debt funds 17.5 years of withdrawals, so she never sells equity after a fall.

Step 1What two questions sort any client into a model?

When will the money be needed, and does the client live on it? A farmer who eats from his granary every week cannot plant all his grain; a farmer with a salary from town can. A long horizon with no withdrawals can carry a lot of equity; a short horizon or a client who draws a living from the portfolio cannot. Age is only a rough stand-in for these two questions. The formal version is risk capacityHow much loss a client can bear without their plans failing, set by horizon, income and needs, as opposed to how much loss they feel comfortable with., and each match below is justified with a number that measures it.

Horizon and dependence on the portfolio decide the match, not age aloneThe saver, 28Rs 12 lakh, adds Rs 30,000 a monthNo withdrawals for 30 years8020Model 80/20: equity / debtThe parent, 50Rs 1.2 crore; Rs 40 lakh for college in years 3-6Retires at 605050Model 50/50: equity / debtThe retiree, 72Rs 2 crore, draws Rs 8 lakh a yearLives on the portfolio3070Model 30/70: equity / debt30 years, no drawsdebt Rs 60 L covers feesdebt = 17.5 years of draws
The saver with 30 years and no withdrawals fits 80/20, the parent fits 50/50 because Rs 60 lakh of debt covers Rs 40 lakh of fees, and the retiree fits 30/70 because Rs 1.4 crore of debt covers 17.5 years of withdrawals.
Step 2What does a bad year cost each client, and can they absorb it?

Run the same 35% equity fall through each match. The saver loses about Rs 3.36 lakh, roughly eleven months of his own savings, with 30 years to recover. The parent loses Rs 21 lakh, but none of it touches the fee money in debt. The retiree loses Rs 21 lakh, about 2.6 years of withdrawals, while her debt keeps paying her. Each loss is real, but none forces a sale at the bottom.

ClientModelEquity, Rs lakhLoss in a 35% fall, Rs lakhWhat absorbs it
The saver, 2880/209.63.3630 years and new savings
The parent, 5050/5060.021.0Fees sit in the Rs 60 lakh of debt
The retiree, 7230/7060.021.017.5 years of draws in debt
A 35% equity fall costs the saver about Rs 3.4 lakh, the parent Rs 21 lakh and the retiree Rs 21 lakh, and in each match the money needed soon sits outside equity.
Step 3What happens if you give the retiree the saver's model?

Swap the models and rerun the fall. At 80/20 the retiree would lose Rs 56 lakh in one bad year, seven years of withdrawals, and with only Rs 40 lakh in debt she would be selling equity at the bottom within five years. That is sequence risk: losses early in a withdrawal phase do damage that later good years cannot undo, because the units sold at low prices are gone. The saver in her model would simply give up growth he did not need to give up. Say which mismatch is worse; the retiree's, because it cannot be repaired.

Where candidates lose it

The common slip is matching by age alone and putting the 50-year-old in 30/70 because a bill is coming. The bill is covered by the debt half of 50/50; the rest of his money is ten-year money.

The second is justifying each match with adjectives, aggressive, moderate, conservative. The interviewer wants the one number per client: months of savings, fees covered, years of withdrawals.

What the interviewer asks next

  • The saver says he will panic if he sees a 25% loss. Does that change his model?
  • The retiree wants to leave Rs 1 crore to her grandchildren. Would you move her toward 50/50?
  • How would you handle a fourth client who fits between two models?

Company names and figures are illustrative.