The Client Who Wanted Income and Growth
A 58-year-old client, Ms. Okafor, has a portfolio worth 2.4 million in local currency. She plans to retire in seven years and needs roughly 90,000 per year in income once retired. Her current allocation is 75% equities, 20% bonds, 5% cash. The equity sleeve returned 22% last year, and she has become convinced equities are the only asset worth holding. She asks you to shift to 90% equities and to sell the bond sleeve, arguing bonds "lost money" in a year when rates rose. She also wants to add a 10% position in a single technology stock that has doubled. She describes her risk tolerance as high but also says she "cannot afford a big drop."
1. Identify the contradictions in the client's stated objectives and constraints, and explain how you would resolve them.
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Two contradictions matter. First, stated risk tolerance (high) conflicts with stated capacity and need ("cannot afford a big drop"). Risk tolerance is attitude; risk capacity is financial ability to absorb loss. A 90% equity portfolio can plausibly fall 40% in a severe drawdown, which would be about 864,000 on a 2.4 million base - far more than a retiree seven years out can absorb while drawing 90,000 per year. Second, her objection to bonds is based on a one-year total return that conflates price and income. A rising-rate year produces mark-to-market losses but also higher reinvestment yields; the bond sleeve's role is to fund near-dated liabilities and dampen drawdowns, not to win a one-year race.
Resolution: document the conversation, restate the goal in cash-flow terms (funded ratio of assets to the 90,000 need), and show a projection under a severe equity drawdown for both 75/20/5 and 90/5/5. Offer a compromise - modest equity increase, keep a bond or laddered-deposit sleeve sized to cover the first several years of retirement spending - and cap the single-stock idea at a small satellite weight with a written rationale. If she insists, record the instruction as an unsolicited, client-directed change.
2. How should the request to add 10% in one technology stock be handled from a suitability and concentration standpoint?
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A 10% single-name position on top of a 90% equity book is a concentrated, idiosyncratic bet. The relevant tests are concentration relative to net worth, correlation with the rest of the equity sleeve, and the client's ability to withstand a permanent 50–70% loss on that position. On 2.4 million, 10% is 240,000 in one issuer - material for someone drawing income in seven years.
Process: quantify the position's contribution to portfolio volatility and to worst-case drawdown, confirm the stock is not already held inside her funds (look-through overlap), and check any issuer or sector limits in the IPS. Recommend a smaller satellite weight, a staged entry, or a diversified thematic fund if the goal is sector exposure rather than a single company. Explain that past doubling is not evidence of future return and that the client is anchoring on recent performance. If she proceeds, obtain written acknowledgment of concentration risk and set a review trigger (for example, rebalance if the position exceeds a stated ceiling).
3. Draft the core elements you would put in a revised investment policy statement for this client.
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A workable IPS would include: (1) Objectives - retirement at 65, target income 90,000 per year, capital preservation priority over growth once funded ratio is near 1.0. (2) Return requirement - the return needed to fund that income with inflation, stated as a number, so the client can see why some lower-volatility assets are required. (3) Risk - maximum tolerable drawdown in currency terms agreed in advance, plus a documented distinction between willingness and capacity. (4) Constraints - liquidity needs for the first three retirement years held in short-duration or cash-like assets; time horizon split into near-term income and long-term growth; tax considerations; any ethical preferences. (5) Asset allocation with permitted ranges and rebalancing bands. (6) Concentration limits, including a cap on any single security. (7) Monitoring, review frequency, and the process for client-directed deviations. (8) Roles and responsibilities, including who executes and who reports. The IPS should be signed and revisited annually or on any material change in circumstances.