Series 7

By Investopedia AAA

Determining Customer Objectives - Determining A Client's Risk Tolerance

Accumulation Phase
An investor in her 20s or early 30s is in what is known as the accumulation phase.

  • Her net worth is probably fairly small and burdened by car and student loan debt.
  • She might not have money, but she does have one important commodity: time.
  • Someday, she may want to have children, send them to college and then retire.
  • But once her immediate investment goals are met - car, down payment on a house - she will still have a long time horizon on her other investments.
  • She will be most interested in growth and can make some fairly high-risk investments with the expectation of making above average returns.

Consolidation Phase
In her mid-30s, the investor will typically move into the consolidation phase.

  • She will likely stay in this phase through her peak earning years, until just before retirement.
  • At this stage, her debts should be nearly paid off, her children's college expenses should be funded and her earnings should exceed her expenses.
  • Retirement and estate planning are her biggest concerns.
  • Through most of the consolidation phase, she will still have a decade or two to consider these big-ticket items, so she will still have a moderate tolerance for risk.

Spending Phase
As the investor approaches retirement, she enters the spending phase.

  • Between Social Security, pensions and interest in other retirement accounts, she has her daily living expenses covered, provided she is invested to receive a steady, predictable income.

  • She has no need to speculate aggressively and desires no financial surprises: the worst that can happen is that she could lose her entire nest-egg; the best that can happen is that she will leave her heirs more of the money she never had a chance to spend on herself.

  • It follows, then, that she is likely to be more risk-averse at this point. Her biggest concern is inflation, and she must incur some degree of risk to cover a potentially shrinking dollar.

  • If the investor is fiscally well-situated, the spending phase might coincide with the gifting phase, during which she will provide for friends and relatives or set up philanthropic trusts. She might also look into trusts as a tax shield as she plans her estate.

Of course, this is an ideal, metaphysical investor. She does not exist. Not everybody knows that, the week after they graduate from school, they are supposed to start accumulating long-term, high-risk instruments. That throws off the whole timeline. As an investment professional, you must be able to make sound judgment calls as to which phase matches the client's situation most closely, while being aware that elements of other phases may enter into the equation.

Questions To Ask Your Client

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