Unit #19: Client Profile
You are onboarding a new client. Which of the following is the least important indicator of the client's risk tolerance? A) Highest education level B) Current age C) Expected retirement date D) Attitude toward taking a loss
A *Although those with more education might be able to understand the concept of risk versus reward, it is far more important to know the client's age, time horizon (expected retirement date helps there), and attitude toward taking a loss.
A client who states that she wants to avoid petroleum company stocks is expressing a A) non-financial consideration B) recommendation C) form of risk avoidance D) financial consideration
A *In all likelihood, this is for a personal value, an environmental concern (good data gathering would probably pick that up) and values are non-financial considerations.
As part of your annual review for clients, you perform a net worth computation. You have computed a specific client's net worth at $500,000. This client calls you and asks what his net worth will be after withdrawing $4,000 from his savings account to pay off credit cards, taking another $6,000 to deposit to his IRA and buying a $25,000 home theater system using store credit. You would respond that the client's net worth is now A) $500,000 B) $466,000 C) $491,000 D) $475,000
A *In each case, we have an asset offsetting a liability so there is no change to the net worth.
To maintain the proper portfolio balance for a client, it would be most appropriate to review the portfolio at least A) annually B) every two years C) every 10 years D) client and portfolio review is not necessary
A *Most advisers would suggest that a client's life situation and portfolio should be reviewed at least annually. More frequently would not be inappropriate.
Tammy has a strong feeling about a particular investment's future performance. She is constantly seeking information to validate her belief that this investment will greatly appreciate. However, she is dismissing any information which is contradictory to this stance. This is an example of which of the following? A) Anchoring effect B) Confirmation bias C) Herd theory D) Prospect theory
B *This scenario is an example of the confirmation bias which states that investors tend to look for information that supports their previously-established decisions and beliefs. Herd theory, or "following the herd", is when an investor jumps on the bandwagon following the lead of others. The anchoring effect is when you base your decisions on initial information received and find it difficult to move away from that decision.
In making suitable investment recommendations, the least significant element would be the client's A) retirement needs B) death and disability needs C) educational level D) current income
C *A client's educational level is not as important as retirement needs, death and disability needs, and current income. However, the agent should take note of the client's educational level to ensure that the client fully understands the investments recommended. Also, a person with a professional educational background may have more employment opportunities and be able to take more risk as a result.
If a widow with no outside source of income and moderate financial resources asked you for investment advice, the most appropriate recommendation(s) would be 1. new issues of common stocks 2. growth stocks 3. speculative issues 4. income securities A) II and III B) I, II, and IV C) IV only D) II, III, and IV
C *A customer with no source of income needs an investment portfolio to generate income. Suitable investments would be income securities that pay interest (bonds) or dividend-oriented stocks (preferred stocks and the common stock of public utility companies). Speculative stocks and growth stocks typically pay little or no dividends because any profits generated are being reinvested in the company's growth by the board of directors instead of distributed to the shareholders.
What is the net worth of a customer with the following personal balance sheet? -Cash $20,000 -Municipal bonds $75,000 -401(k) account value $150,000 -Salary $80,000 per year -Cars $30,000 -Home $250,000 -Miscellaneous (jewelry, etc.) $50,000 -Personal loan $10,000 -Car loan $20,000 -Mortgage $150,000 -Monthly mortgage payment $1,500 A) $473,500 B) $245,000 C) $395,000 D) $95,000
C *A customer's net worth equals assets minus all liabilities ($575,000 − $180,000 = $395,000). Salary and mortgage payments are income and expense items and are not part of net worth.
Which of the following situations would most likely cause an individual's application for a disability income insurance policy to be denied? A) Being over 50 years of age B) Type 2 diabetes C) Working in a hazardous occupation D) BMI over 26
C *In most cases, those who work in hazardous occupations will be denied disability income coverage. Premiums will be higher as one gets older and Type 2 diabetes or too high a BMI can lead to a premium surcharge (rated), but those are generally not causes for denial of coverage.
A client profile is not complete without a family income statement. A typical one would include 1. dividends 2. credit card debt 3. autos 4. mortgage interest A) II and III B) III and IV C) I and IV D) I and II
C *Income statements reflect the family's income and expenses, not assets and liabilities. Dividends represent money received, and mortgage interest is money paid out. Credit card debt is a liability and autos are assets.
Insurance agents frequently use a capital needs analysis to help determine the correct amount of life insurance needed by their clients. That analysis would look at all of these EXCEPT A) life expectancy B) the inflation rate C) market volatility D) future earnings
C *Of these choices, the only one that we cannot in anyway predict is market volatility. We can factor in an estimated inflation rate, project future earnings, and look at the mortality tables to obtain life expectancy. But nothing can project market volatility with any degree of accuracy.
When interviewing a new client, the discussion leads to the damage done to the environment by oil spills. The client mentions the names of some large petroleum companies and says that she does not want stocks like that in her portfolio. In so doing, she is expressing A) financial consideration; those companies don't pay dividends. B) nonfinancial consideration; her knowledge. C) nonfinancial consideration; her values. D) financial consideration; she already has enough money.
C *One of the nonfinancial considerations that must be reckoned with is the client's values. These are shaped by life experiences and will often influence investment decisions. If the client believes in saving the environment, then the IA (or IAR) needs to know what investments to avoid.
Gathering information about a prospective advisory client would probably not be done by A) chat over a lunch B) personal interview C) use of a questionnaire D) using a third party interviewer
D *Because of the confidentiality of the kind of information an investment adviser needs to properly act as a fiduciary in handling a new client's account, it is unlikely that the role would be delegated to an outside third party.
An investment adviser representative's client lost her father to lung cancer. Among the assets bequeathed to her were 2,000 shares of a tobacco stock. Which of the following is NOT a consideration when recommending to her what to do with the stock? A) Her employment situation B) Her financial goals C) The cause of her father's death D) Her father's years of investment experience
D *An adviser's recommendations to a client are not impacted by the degree of someone else's investment experience or knowledge. In this case, one could expect some resentment towards holding shares of a tobacco company when the cause of a loved one's death is lung cancer.
An individual's net worth is A) largely irrelevant in identifying the individual's investment objectives B) another term for discretionary income C) best determined by examining the individual's personal income statement D) the difference between the individual's assets and the individual's liabilities
D *An individual's net worth is the difference between the individual's assets and the individual's liabilities. It is determined from the personal balance sheet rather than the personal income statement. Net worth is relevant in determining an individual's investment objectives.
Which of the following would be appropriate actions when using a model portfolio for a client? 1. Gather information from the client to establish his risk tolerance, time horizon, and investment expectations. 2. Select a portfolio mix that is appropriate for the client based upon his risk tolerance, time horizon, and investment expectations. 3. Place the client's assets into the model portfolio regardless of his comfort level with your recommendation. 4. Periodically review the portfolio to determine if any changes or modifications are necessary. A) I, II, III, and IV B) I, II, and III C) I and II D) I, II, and IV
D *Gathering information relating to your client's risk tolerance, time horizon and objectives would all be prudent steps in assisting your clients in the establishment of a model portfolio. It would never be acceptable to place a client into an investment portfolio model that they were uncomfortable with, even if you have determined it to be suitable and appropriate.
Investment advisers must recognize the difference between their client's goals and objectives and investment constraints. Which of the following would be considered an objective rather than a constraint? A) Tax concerns B) Changes to laws and regulations C) Time horizon D) Income in retirement
D *Income, whether for current or future needs, is an objective. The other choices represent investment constraints—things that must be dealt with in order to reach the goal of meeting the objective.
All of the following are reasons why broker-dealers and investment advisers gather information about their customers EXCEPT A) for use in advertising B) to maintain accurate customer records C) to use in determining suitability D) to comply with BSA requirements
A *It would generally be considered a violation of privacy rights to use specific customer data in advertising without express consent. This is particularly true for investment advisers where testimonials are prohibited. Information must be gathered in order to make suitable recommendations, and the Bank Security Act as well as federal and state law have recordkeeping requirements.
Which of the following best describes the determination of a client's risk tolerance? A) The client's ability and willingness to take risk B) The client's net worth C) The client's willingness to take risk D) The client's ability to take risk
A *Risk tolerance is a combination of two factors. One is the emotional willingness to face a loss and the other financial capacity to absorb a loss without a change in lifestyle. The client's net worth gives an indication of the capacity, but says nothing about the emotion.
An investment adviser has a client who wants to save for college for her child. The child will be entering college in 5 years. This would be an example of A) an investment constraint B) tactical asset allocation C) a capital need D) planning too late
A *The goal is having money for college. The investment constraint (obstacle in the way of meeting the goal) is the short time horizon. It may be true that the client has started too late, but that is not what the exam would be looking for as the correct answer.
An elderly widow with no independent income wishes to invest the proceeds from her recently deceased husband's life insurance. Which of the following would be the most suitable recommendation? A) High-grade corporate bond mutual fund B) Oil and gas exploration program that you know is going to strike C) Municipal bonds D) Call options
A *This customer needs income. Of the answers provided, the bond fund would be the most suitable because it would provide income while maintaining relative safety. While the municipal bonds are probably safer, the benefits of their tax-free income would probably be lost on a client with no independent income.
If a new client has $200,000 to invest and wants to retire in 15 years, which of the following client information is least necessary for an adviser to recommend a suitable investment program? A) Current income and cash flow requirements B) The amount of income he requires for his retirement years C) Tolerance toward risk D) The age of the client
A *While current income and cash flow requirements are ordinarily important considerations, in this question we are being asked about the investment of a lump sum, not periodic additional investments. The amount of income required will determine the types of investments and how they must be structured in order to achieve the retirement income desired. The client's age is necessary to determine the time horizon. That is, if the client is currently 35 and wishes to retire at age 50, the money will have to last a lot longer than if we are dealing with a 55-year-old who wishes to retire in 15 years at 70. A client's tolerance toward risk is among the most important non-financial considerations in determining investment suitability.
Which of the following would be considered an investment constraint rather than an investment goal? A) Growth of capital B) Current income C) Capital preservation D) Liquidity
D *Investment constraints are those things that limit our ability to reach our goals. If the investor needs high liquidity, that factor will affect the investment selection process and place a limit on the available investment options.
When making a customer profile, one of the documents created is a balance sheet. Among other items, your client's balance sheet would include A) interest expense B) assets C) accumulated depreciation D) salary or wages
B *A balance sheet, whether for an individual, a family, or a business, is a listing of assets and liabilities. Interest expense and salary go on the income statement. Accumulated depreciation is a balance sheet item, but only for a business.
When preparing a client's personal profile, it is generally accepted that there are both financial and non-financial considerations evaluated in order to issue appropriately suitable recommendations. Which of the following would not be included in the list of financial considerations? A) Vested interest in the employer's 401(k) plan B) Risk tolerance C) Income from rental properties D) The client's marginal tax bracket
B *A client's risk tolerance is a non-financial consideration; it is an attitude. Income from a rental property, tax obligations, and available retirement funds are all financial considerations that contribute to determining suitability.
One problem facing agent and client alike is determining how much life insurance is necessary to meet future needs. One tool that is useful for making that determination is A) a mortality table B) a life insurance capital needs analysis C) a statement of beneficiary needs D) a premium purchase analys
B *A life insurance capital needs analysis takes into consideration the future needs of the insured and family and then factors in how much needs to be filled in by life insurance.
If a customer purchases shares in a municipal bond fund, which of the following statements are TRUE? 1. Dividends are taxable. 2. Dividends are not taxable. 3. Capital gains distributions are taxable. 4. Capital gains distributions are not taxable. A) I and III B) II and III C) I and IV D) II and IV
B *Dividends distributed by municipal bond funds are federal tax free (and in some cases, state tax free as well) in alignment with the tax rules of how the fund's investment income was earned. However, any capital gains distribution resulting from the sale of bonds held long term by the fund is subject to taxation to the shareholder.
An investment adviser cannot adequately advise a client without knowing the client's financial status. When determining that status, it is important to differentiate between financial and nonfinancial considerations. Which of the following would be considered a financial consideration rather than a nonfinancial one? A) Client's marital status B) Client's stamp collection C) Client's membership in Greenpeace D) Fact that both parents were smokers who died of lung cancer
B *Financial considerations are those which can be categorized as an asset or a liability (something that can be assigned monetary value). Although a stamp collection would not be considered a very liquid asset, it is nonetheless something of monetary value. The other choices are nonfinancial because you really can't put a number on them. The Greenpeace membership and the lung cancer deaths of the parents are likely indicators of certain investments that would probably not be suitable due to the values of the client.
A customer within 1 year of retirement informs his agent that he wants to use the equity in his house to make enough money within the year to fully fund his retirement. According to the Uniform Securities Act, the agent should A) construct a growth-oriented portfolio B) urge the customer to reconsider his investment strategy C) invest the money in high-tech securities because of their unlimited potential D) invest in an ultraconservative portfolio of municipal bonds
B *Making unsuitable recommendations to customers is prohibited, and this investor's time frame is unrealistic because the customer cannot meet his objectives in the time allotted. Investment in high-tech securities is unsuitable. Advising the customer to invest in an ultraconservative portfolio of municipal bonds will not meet the customer's objective of capital growth. The agent should advise the customer to reconsider his investment objectives.
A 45-year-old investor wants the greatest possible monthly income with the preservation and stability of capital as secondary objectives. Which of the following investments would you recommend? A) Money market mutual fund B) Long-term bond fund C) Growth mutual fund D) Growth and income fund
B *The only choice that provides stability of capital is the money market fund, but that is not one of the investor's objectives and the monthly income is quite low. Although the 2 other funds don't offer stability, they certainly don't provide a high income (even the growth and income fund). If you want income, you invest in bonds, especially those with longer maturities.
When developing a client profile, it is important to note both the financial and nonfinancial considerations. These can be categorized as those that are objective and those that are subjective. Included in the list of subjective considerations would be A) cash value of life insurance B) balance on the home mortgage C) the family balance sheet D) risk tolerance
D *Subjective considerations are the nonfinancial ones—the ones that can't be expressed in monetary terms. Risk tolerance is one of the key subjective considerations to be evaluated.
A client of an investment adviser excitedly calls the adviser with the news that he is now going to handle his own investments. "I just read some great investment books, and now I know what to do." Based on the study of behavioral finance, it would appear that this individual is A) following the herd. B) conservative. C) anchored. D) overconfident.
D *The behavioral finance bias of overconfidence refers to the observation that experienced (and even some "rookie") investors tend to overestimate their ability and the accuracy of the information available to them.
Which of the following is the least significant consideration in making an investment recommendation to a client? A) Investment objectives B) Age C) Net worth D) Education
D *When making suitable investment recommendations, agents must take the client's age, net worth, and investment objectives into consideration. A client may not have a college education, but may be more sophisticated financially than someone holding a PhD in English literature.
If an investment adviser uses a client questionnaire to determine a client's financial situation, the adviser is A) acting unethically, as this information may be used to determine how large an advisory fee to charge B) acting ethically, as the information is necessary to determine the suitability of recommendations C) acting unethically, as client information is confidential D) acting correctly to determine if a conflict of interest exists
B *Advisers must make reasonable inquiry into the client's needs, investment objectives, and financial situation to make suitable recommendations. Advisers must keep client information confidential and not disclose the information to any third party without the client's consent. Conflicts of interest must be disclosed, but that is not the reason for obtaining client information. The adviser's fee may be based on the services performed, advice provided, and/or assets under management, but not on the client's financial situation.
A couple, ages 63 and 66, are long-time clients of your firm and are in good health. They plan to retire from gainful employment in 4 years and wish to discuss decumulation strategies. One of the important factors to consider is the time horizon for this couple. Which of the following would be the best estimate to use? A) 10 years B) 25 years C) 8 years D) 4 years
B *Decumulation is the opposite of accumulation. Instead of focusing on how to increase the assets, the focus is on how to make sure they last as long as required. Just how long is that time horizon? Until the death of the second party. Today's statistics would indicate that a couple of these ages would likely have at least one of the two live another 25 years.
One of your clients excitedly calls to inform you that his daughter has just been accepted for the coming year into the engineering program at one of the most respected universities in the country. She has been given a generous scholarship but that will leave the family short by about $100,000 for the 4-year program. You check the client's account and see that the current value is $25,000. The client offers to add another $25,000 and asks you if you think the account performance over the next 4 years can provide the necessary funds. You would probably reply A) this is wonderful news and you are pleased that the client has selected such a worthwhile goal B) the short time horizon is an investment constraint that will make reaching this goal highly unlikely C) his daughter should consider attending a community college instead D) that the goal seems attainable if the client is willing to assume the necessary risk
B *Investment constraints are those things that get in the way of reaching our goals. One of the most important of these constraints is the time horizon. If this client had more time, it is possible that the goal could be reached, but, under the current conditions, the risk that would have to be taken would likely be far beyond an acceptable one.
A customer has a financial commitment of $200,000 that will come due in 2 years. In the interim, the customer wishes to invest the $200,000 to maximize income and have the money available for the obligation in 2 years. You should recommend investments in A) large-cap stocks B) government securities with two year maturities C) municipal bonds purchased at par with 20-year maturities D) preferred stock purchased in a private placement
B *The Uniform Securities Act requires that all recommendations to a customer be consistent with that customer's investment objectives and financial situation. This particular customer needs to have principal available in 2 years and wants to invest for income in the interim. Time horizon is one of the most important constraints an investment adviser must consider. Of the choices listed, only government securities with 2-year maturities meet both criteria.
Many financial planners recommend that clients wait until age 70 to begin their Social Security retirement benefits. The primary reason for this recommendation is that A) taking payments prior to age 70 increases the likelihood that you will run out of money sooner than if you wait B) by waiting past full retirement age (currently 66), your payments will grow at an annual rate of 8% C) once you've reached age 70, there is no limit to the amount that may be earned without affecting monthly payments D) by waiting, you increase the amount that Social Security will pay for burial expenses
B *The maximum benefit depends on the age you retire. For example, if you started taking benefits at full retirement age in 2019, your maximum benefit would be $2,757. However, if you began at age 62 in 2019, your maximum benefit would be $2,245. If you waited until age 70 in 2019, your maximum benefit would be $3,770—that is because after age 66 (current full retirement), the benefit grows at an annual rate of 8%. Earnings don't impact Social Security payments once you've reached full retirement age, not 70. A surviving spouse or child may receive a special lump-sum death payment of $255 for burial expenses, regardless of the age at death or the age at which benefits began.
A couple in their early 30s has been married for 4 years, their disposable income is relatively high, and they are planning to buy a condominium. If they need a safe place to invest their down payment for about 6 months, which of the following mutual funds is the most suitable for these customers? A) ABC Growth & Income Fund B) LMN Cash Reserves Money Market Fund C) XYZ Investment-Grade Bond Fund D) ATF Capital Appreciation Fund
B *These customers are preparing to make a major purchase within the next few months, so they require a highly liquid investment to keep their money safe for a short amount of time. The money market fund best matches this objective.
Otto and Lucy set up a 529 plan to save funds for the college education of their daughter, Marangue, who is 14. What is the most suitable investment for the largest portion of their contribution? A) A long-term bond fund B) An intermediate term bond fund C) A large-cap stock fund D) A growth stock fund
B *This is a straight suitability question. Match the time horizon to the investment offered, and an intermediate term bond fund is the only logical answer.
If an investor has $20,000 to invest, but requires $500 per month to pay for her mother's nursing home care, which of the following funds should you recommend? A) Foreign stock B) Aggressive growth C) Money market D) Biotechnology
C *The client's monthly income requirements suggest that the money market fund, the most liquid and safest of the investments, is the most appropriate.
Rendering investment advice requires knowing certain information about your client. Which of these would be the least reliable source of that information? A) Your firm's confidential planning questionnaire B) Client's income tax returns C) Client's Facebook page D) Face-to-face meeting with the client
C *There are a number of ways to gather information about your client's financial resources, but it is highly unlikely that a social media page would be one of them.
Several investors open an account in joint tenancy. Financial information is required on which of the following investors? A) All the investors B) The largest investor only C) The majority of the investors D) Only the one authorized to trade the account
C *When a joint account is opened, financial information should be obtained on all the account owners.
Carol is opening an investment account with her agent and will be expected to disclose all the following items of financial or personal information EXCEPT A) age B) investment experience C) educational background D) annual income
C *When an agent opens accounts on behalf of a broker-dealer, it is required to ask each applicant to disclose date of birth, and to request annual income and net worth, as well as investment experience. Disclosure of educational background is not typically sought.
It would be correct to state that when an investor has a longer time horizon, A) the risk level is lowered B) the greater the initial deposit to reach a projected future goal C) the need for liquidity is less important D) the exposure to inflation risk is lessened
C *When the time horizon is long, there is little need for access to the funds now. Therefore, liquidity is a minor consideration. With a long time horizon, the investor can take greater risks (and should because it will be necessary to combat the higher inflation risk).
One respect in which an investment adviser differs from an agent for a broker-dealer is that of fiduciary responsibility to the client. Therefore, the IA will have greater concerns about various non-financial needs and attitudes of the client when making recommendations. Included in those concerns would be all of these EXCEPT A) the client's attitudes toward the environment B) the client's time horizon number and age of dependents C) the client's marital status D) the client's retirement plan vested balance
D *The vested balance in the client's retirement plan is a critical factor in determining what additional (if necessary) will be necessary to meet retirement goals, but is a financial rather than non-financial consideration. The other choices can't be measured in terms of dollars and cents.
Your 47-year-old client plans to retire at age 65. When constructing a recommendation for the client's $850,000 IRA rollover account, your first consideration should be the client's A) tax status B) planned retirement age C) liquidity needs D) risk tolerance
D *While tax status, planned retirement age, and liquidity needs are important considerations in determining a client's investment profile, the first concern that should be addressed in this case is the client's risk tolerance.
