How to tackle IPS questions ??

First part to IPS questions, the stories in the long vignette that’ll give you clues about the investor.

Normally, the IPS questions will start of “light” with a few easy ones, and there are mainly 3 types of “starter” questions.

#1. Situational profiling
You need to know this, i.e. how to categorise investor types by economic situations and life-stages.

• Source of wealth – manner of wealth often indicates investor sophistication and risk-profile. E.g. wealthy entrepreneurs tend to exhibit experience and knowledge in risk-taking, whereas windfalls, inheritance and steadily-accumulated wealth tends to exhibit less familiarity around risk-taking
• Measure of wealth – perception of investor on wealth level. Generally, the more wealthy an investor perceives himself, the more risk-taking
• Stage of life – generally inverse relationship between age and risk-taking, i.e. young and risky, old and conservative

#2. Psychological profiling and Behavioural Finance
IPS questions tend to touch this area of knowledge as well. So make sure you know these common psychological traits of investors, and their definition:

• Loss aversion: individual’s reluctance to accept/realise a loss or hold on to losers too long (in hope of a comeback), leading to higher risk-taking behaviour
• Biased expectations
• Pyramiding, or mental accounting: where an investor creates an arbitrary diversifying ‘pyramid’ of investments, starting from least risky ‘for planned expenditure e.g. children’s education’ to riskier investments. From an economics and investment theory standpoint this diversification theory makes no sense.

#3. Investor Types
Then finally, another variation is this where the IPS question asks you what type of investor is this person considered as. You need to know the terms and definition of these:

• Cautious investors – prefer safe investments and do not like making their own investment decisions
• Methodical investors – research markets, industries and firms to gather investment information, investments tend to be conservative
• Individualistic investors – do their own research, are confident in their ability to make investment decisions and are more risk-taking than methodical investors
• Spontaneous investors – constantly adjust portfolios to market conditions, lack investment expertise, react to changing investment trends. Tend to over-manage portfolio, high transaction costs

Give me 30 min on this, it’s gonna be a LONG answer @Lakshya25… 🙂

Blimey! If I were @zee I would award you the ‘Epic Post’ badge!

Will def go through this with a fine tooth comb! Thanks!

Maybe I should start lobbying for a talkative badge. @Sophie what is the most efficient way to bribe @Zee?

At this rate I’ll need to manage badges as a full time role. [-(

I officially step down from being a lobbyist. This short stint illustrates that I’m not good at it. Till next time!

Holy mother of god. I’m bookmarking this now as it’ll be useful when I’m taking Level 3! Cheers @Sophie

Didn’t expect you to looked at L3 stuff while you were doing L2! *Salute*

@sophie this is definitely very helpful! Outstanding post indeed! :-bd

@lakshya25 indeed! You might find a related link useful though,

https://300hours.com/f/cfa/level-3/t/useful-links-from-analyst-forum/#latest

I’ve awarded it a ‘promote’, which is a super like! 😀

Epic post indeed! Thanks @sophie.

Holy mother of god. I’m bookmarking this now as it’ll be useful when I’m taking Level 3! Cheers @Sophie

@Sophie, I just noticed these posts…absolutely outstanding. Just came on here to ask some IPS questions, and your post answered most of them. Seriously, so helpful, to the point, and accurate. Thank you.

With that said, I still do have a question. I seem to be struggling on “time horizon.” My initial understanding was that the stage of the time horizon changes any time there is a significant change in circumstances. For instance, in question 1 in the CFA 2008 AM exam, I put something to the effect of:

“They have a long, multi-stage horizon. The first stage spans from now until their children enter college (in about 14 years), the next stage is while their kids are in college, the third stage is when their kids are out of college and no longer dependent on them, and the final stage is retirement.”

However, the answer given by CFA was simply:

“The Carvalhos have a long-term multi-stage time horizon. In the short term,
they must pay living expenses and provide a home for their family. They
may also have to pay tuition for their children. Their second stage is
retirement, thirty years from now.”

How do I know what is significant enough to constitute a stage of the time horizon, other than retirement?

@sophie this post really helped a lot. thank you very much for posting this.

Sophie you just gave us extremely nice info for not a dime! Thank you. A holiday in Africa would be available at ours! im serious!

Part 2 to answer the main parts of a typical IPS question, the “fun” bits on Investor Objectives and Constraints, i.e. the classic RRTTLLU: Risk, Return, Time horizon, Taxes, Liquidity, Legal & regulatory, Unique circumstances.

So here are a collection of tips from my previous experience on Level 3 IPS questions for each of the section.

Objectives

1. Risk – only use average, below average or above average to describe it.
• Willingness – investor intent towards risk
• Ability – investor capability towards risk, independent of intent
• Overall – when investor willingness and ability different, always honour the more conservative and suggest investor education to reconcile the difference
2. Return – driven by annual liquidity & expenditure needs and tax
• Before-tax return, R = r/(1-t), whereby r = annual liquidity needs / total portfolio value, t = taxes
• If risk-return objectives are inconsistent (e.g. can’t achieve return without violating risk objectives), note the inconsistency in the risk objective, recommend client education and portfolio objective reassessment

• Time horizon – usually at least 2 time horizons, pre-retirement and retirement. Time horizons are separated by a need to adjust the IPS
  • ** TIP ** In the exam, define number of stages and years (if identifiable). If client wants to maximise bequest to heirs, it's a multigenerational time horizon

• Taxes – must always consider & identify individual tax circumstances. If unsure about tax treatment, include recommendation for legal counsel on either tax or regulatory
  • ** TIP ** In the exam, identify if the annual portfolio returns are subject to tax. E.g. dividends and interest income received outside retirement accounts are taxable. If not sure about tax treatment, include a recommendation for legal counsel either on tax or regulatory section

• Liquidity – spending needs to be met by the portfolio
  • Immediate (current one offs)
  • Ongoing (living/medical expenses)
  • Other (e.g. house in future, expected receipt of large cash flow)
  • ** TIP ** In the exam, include all actual spending needs that needs to be covered by portfolio. 3 categories of spending needs: immediate, ongoing (living/medical expenses) and other (e.g. plan to pay cash to buy house in future or expectation of receiving large cash flow in future).

• Legal & regulatory – can always recommend legal counsel. If no noticable legal concerns, Prudent Investor Rule applies. Individuals usually have minimal L&R concerns, unless trusts are involved, in which case issues are complex and legal counsel recommended:
  • Revocable trusts
  • Irrevocable trusts
  • ** TIP ** In the exam, if no noticable legal concerns, mention that Prudent Investor Rule applies. If question on trust/foundations, just say issues are complex and legal counsel is recommended

• Unique circumstances – usually individual constraints present, such as avoid certain class of security or industry, or overweight a certain stock, moral objections etc
  • ** TIP ** In the exam, this section can be left as ‘none’ or a variety of items. If client portfolio includes a lot of investments in companies founded by client/relatives, this needs to be mentioned. If question instructs to NOT include client’s home in the value of investable portfolio, this is the place to state it.

@Sophie The first part that you answered reg. situational profiling,etc can be a standalone question, isn’t it?

Is it possible that they can combine the RRTTLLU part with situational profiling, behavioral finance, psychological profiling in one question? Or does the question/case details usually carry over to the next one?

I did go through the Schweser video on IPS, where they walk you through one of the previous exam papers. Some of the questions asked you to respond on maybe 2-3 of the constraints within the template provided.

@Zee this badge would be about how fast you acquire the #comments badge 😀

This will be based on the # of posts per day xD

I think bribing will work better in this case

@Zee this badge would be about how fast you acquire the #comments badge 😀

This will be based on the # of posts per day xD

I think bribing will work better in this case

Not sure though, commenting for commenting’s sake is not the goal here. Epic, helpful, funny or useful posts are what we wanna encourage 🙂

Additional question related to what I posted above: Does retirement consist of one stage or two? Because in one of the readings it discusses the lifecycle stages (can’t remember the first stage, but the others are accumulation, maintenance, and distribution), in which the latter two both take place in retirement. Maintenance is the majority of retirement (I think) and distribution is when you actually start distributing your net worth. Wouldn’t this be two stages? Or am I reading too much into it?

There is a # Comments badge achievements series @diya!

Thanks Sophie!
But I also wanted to clarify one thing, which I seem to be a little bit confused and is not really dealt with in the CFAI currc. If an outflow is expected to occur, for example within one year from when you are creating the IPS, do you deduct the amount from the total portfolio?
Because it seems like that in some past exams they do and some don’t explicitly mention it – which is making me confused

Thanks!

You’re welcome @Ravivooda

Hi @Lakshya25, perhaps it’s better to explain what aspect of IPS you find challenging? It’s quite a broad question 🙂

Hope you guys find it useful, it’s the last stretch to getting a charterholder!

@Sophie ^:)^ ^:)^ ^:)^

@lakshya25 Which other sources are you using for practicing IPS questions other than Schweser?

Yup @Ajfinance, that can be standalone. I was just categorising the typical IPS ‘warmup’ questions into 3 categories.

I’m not sure what you meant by combining? It’s usually various parts of an IPS question, no rules per se on what order they come in. So I suppose it’s possible to combine.

Yup 2-3 constraints is not abnormal, they will ask on various aspects of the RRTTLLU.

You’re welcome @Lakshya25! Let us know how things are going. You have a few cool peers around taking Level 3 too like @Ajfinance and @MattJuniper to discuss 🙂

Good to know, thank you @Sophie.

@zee, as Master Badge Collector @mattjuniper said – I need an Epic Post Badge 😛

Maybe I should start lobbying for a talkative badge. @Sophie what is the most efficient way to bribe @Zee?

Hmm… dude food like burgers may work . Other than that in goes into nerdier stuff like tech gadgets or keeping is forum fun, nice and tidy. I suspect the latter is efficient virtually!

:))

@padniaki – you’re welcome. I put these on precisely because essay questions were hard and I messed it up in mine. And no one else talks about it! So glad they are useful 🙂

I think your answer above is perfect, more detailed than CFA’s. You recognised the key stages that the income requirement may change due to changes in circumstances. So that’s fine. As long as the key points are noted down, you shouldn’t be penalised for being more thorough than them (but that doesn’t mean you waste extra time writing everything down to the last detail!).

On your second question: It depends on the question really, maintenance and distribution could be considered 2 stages. The point of the question is not really how many stages they are but description of those stages. So if you segment them more but covers the same points I dont think you’d be penalised.

That would be epic @SilverUpholders‌ – will keep that in mind 😀