Financial Advisor Personal Financial Advisor 5 — Questions and Answers
Question 1: Which of the following is NOT a characteristic of a qualified retirement plan under IRS guidelines?
- Tax-deductible employer contributions
- Tax-deferred growth on investments
- Unlimited annual contribution amounts (Correct answer)
- Subject to required minimum distribution rules
Correct answer: Unlimited annual contribution amounts
Qualified retirement plans have annual contribution limits set by the IRS; unlimited contributions are not permitted.
Question 2: What is the wash-sale rule?
- A rule requiring investors to hold securities for at least 30 days before selling
- A rule disallowing a tax loss if the same or substantially identical security is repurchased within 30 days before or after the sale (Correct answer)
- A rule requiring broker-dealers to report all securities sales to the IRS
- A rule preventing investors from selling securities at a loss more than twice per year
Correct answer: A rule disallowing a tax loss if the same or substantially identical security is repurchased within 30 days before or after the sale
The wash-sale rule disallows claiming a capital loss if the taxpayer buys the same or substantially identical security within 30 days before or after the sale.
Question 3: A 40-year-old client has a moderate risk tolerance and a 25-year investment horizon. Which asset allocation is MOST appropriate?
- 100% bonds for capital preservation
- 20% stocks / 80% bonds for safety
- 70% stocks / 30% bonds for growth with some stability (Correct answer)
- 100% stocks for maximum long-term growth
Correct answer: 70% stocks / 30% bonds for growth with some stability
A 70/30 stock-to-bond allocation aligns with a moderate risk tolerance and long time horizon, providing growth potential while managing volatility.
Question 4: What is the primary purpose of rebalancing a portfolio?
- To maximize returns by increasing exposure to outperforming assets
- To restore the portfolio to its target asset allocation after market movements have shifted the mix (Correct answer)
- To minimize taxes by selling underperforming assets
- To eliminate all fixed-income holdings during periods of rising interest rates
Correct answer: To restore the portfolio to its target asset allocation after market movements have shifted the mix
Rebalancing returns the portfolio to its intended asset allocation, managing risk that can increase when one asset class grows disproportionately.
Question 5: Which of the following describes sequence-of-returns risk?
- The risk that inflation will erode purchasing power over time
- The risk that poor early investment returns during the withdrawal phase can permanently deplete a portfolio faster than average returns would suggest (Correct answer)
- The risk of reinvesting coupon payments at lower interest rates
- The risk that a client outlives their assets due to longevity
Correct answer: The risk that poor early investment returns during the withdrawal phase can permanently deplete a portfolio faster than average returns would suggest
Sequence-of-returns risk is especially dangerous during the early retirement withdrawal phase, as large losses early on reduce the principal available to benefit from later recoveries.
Question 6: A client asks about the difference between a traditional 401(k) and a Roth 401(k). Which statement is accurate?
- Traditional 401(k) contributions are post-tax; Roth 401(k) contributions are pre-tax
- Roth 401(k) withdrawals in retirement are tax-free; traditional 401(k) withdrawals are taxed as ordinary income (Correct answer)
- Roth 401(k) plans have lower contribution limits than traditional 401(k) plans
- Traditional 401(k) plans are not subject to required minimum distributions
Correct answer: Roth 401(k) withdrawals in retirement are tax-free; traditional 401(k) withdrawals are taxed as ordinary income
Roth 401(k) contributions are made with after-tax dollars, so qualified withdrawals in retirement are tax-free, while traditional 401(k) withdrawals are taxed as ordinary income.
Question 7: Which behavioral finance concept describes an investor's tendency to hold onto losing investments too long while selling winners too soon?
- Anchoring bias
- Recency bias
- Disposition effect (Correct answer)
- Confirmation bias
Correct answer: Disposition effect
The disposition effect is the tendency to sell winning investments quickly to lock in gains while holding losing investments to avoid realizing a loss.
Financial Advisor Personal Financial Advisor 5
Which of the following is NOT a characteristic of a qualified retirement plan under IRS guidelines?