Know-Your-Client (KYC) & suitability

This is the most examined confusion in the element. Learn it as three separate questions, because the exam will hand you a client where the three answers disagree.

Risk tolerance asks what the client will accept. It is emotional and behavioural. Experience, the size of the account, and how the last market fall felt all move it. A client who says they would sell in a fifteen percent decline has a low tolerance, whatever their income statement says.

Risk capacity asks what the client can survive. It is financial and objective. Income stability, liquid reserves, time horizon, debt, spending needs, and the consequence of a large loss all feed it. A client with a secure pension and no debt has high capacity even if their stomach is weak. Chapter 6 takes the allocation that follows from this profile and builds a portfolio around it.

Risk need asks what the client must earn to reach the goal. A client who needs eight percent a year to fund retirement has high risk need, whatever their temperament. A client whose indexed pension covers their spending may need almost nothing from the portfolio. The syllabus adds two inputs to risk need that candidates skip: the market risk environment at the time, and the consequence of failure. A goal that fails gracefully is a different goal from one that fails into destitution.

When the three disagree, you do not average them, and you do not pick whichever one lets you sell the product you had in mind. You resolve the conflict in conversation, in writing, and with the client's participation. Then you document what you resolved.

Two conflicts recur, and both are exam favourites.

The client needs eight percent and their tolerance supports five. The answer is not to buy the eight percent portfolio and warn them. The answer is to revisit the goal, the savings rate or the timeline, because a plan that only works if the client's money is at risk beyond their comfort is a plan with a built in client exit.