Risk profiling, product suitability and recommendations
What the exam tests
Suitability questions ask you to distinguish risk tolerance from risk capacity, match products to goals, and justify a recommendation on costs and benefits, not on a questionnaire score alone.
Core rules
- Risk tolerance is willingness to accept volatility or loss; risk capacity is the financial ability to bear it. Capacity is driven by time horizon, liquidity needs, debt, income stability and dependants. Risk need is what the goal requires.
- Suitability (Code Standard 3) requires advice suited to the client's goals, financial situation and risk tolerance, with regard to the costs and benefits. A suitable product is not necessarily the cheapest or the highest-performing.
- For investments, consider diversification, fees, liquidity, flexibility, tax and the fund's objective. Past performance is not a promise.
- For insurance, assess the need, sum insured, policy definitions, exclusions, waiting periods, premium affordability and existing cover. Replacement business needs a like-for-like comparison to avoid churning.
- Record why alternatives were rejected.
Worked example
A 60-year-old has $100,000 for a five-year horizon and needs $20,000 accessible for a roof. Her questionnaire score says "growth". The adviser notes capacity is constrained: a 30% fall would leave less than the roof cost. The recommendation is a diversified balanced fund with a cash allocation, plus a term deposit for the roof. The adviser explains the expected lower return and records that the questionnaire score was overridden by capacity and liquidity.
Traps
Treating a risk score as the answer; ignoring capacity and emergency needs; recommending a product because it pays more commission; failing to compare replacement policies; recommending cover the client cannot afford; assuming a long horizon without checking.