IAR Client Investment Recommendations & Strategies 4 — Questions and Answers
Question 1: Under the prudent investor standard, an IAR managing a discretionary account must evaluate investments primarily based on:
- Each security's individual merit in isolation
- The role each investment plays within the total portfolio context (Correct answer)
- The investment's historical five-year return
- The popularity of the investment among retail investors
Correct answer: The role each investment plays within the total portfolio context
The prudent investor standard requires evaluating how each investment contributes to total portfolio risk and return, not assessing securities in isolation.
Question 2: A client with no emergency fund wants to invest all liquid savings in illiquid private equity. What concern should the IAR raise?
- Private equity has lower expected returns than public equity
- The client may need to liquidate at a loss if an emergency arises, as private equity lacks liquidity (Correct answer)
- Private equity is not regulated by the SEC
- The minimum investment threshold is too high
Correct answer: The client may need to liquidate at a loss if an emergency arises, as private equity lacks liquidity
Without an emergency fund, the client risks being forced to sell illiquid assets at unfavorable terms in a crisis, violating the liquidity component of suitability.
Question 3: Which strategy is specifically designed to fund a known future liability, such as a child's college tuition in 10 years?
- Tactical asset allocation
- Asset-liability matching or liability-driven investing (Correct answer)
- Momentum-based sector rotation
- Short selling of volatile assets
Correct answer: Asset-liability matching or liability-driven investing
Liability-driven investing (LDI) matches the duration and cash flows of assets to a specific future obligation, minimizing the risk of a funding shortfall.
Question 4: A client in the distribution phase of retirement asks about sequence-of-returns risk. An IAR should explain that this risk refers to:
- The risk that bond yields will fall during retirement
- The risk that poor early returns combined with withdrawals can permanently deplete a portfolio (Correct answer)
- The risk that inflation will erode purchasing power over time
- The risk of receiving dividend payments out of order
Correct answer: The risk that poor early returns combined with withdrawals can permanently deplete a portfolio
Sequence-of-returns risk describes how early portfolio losses during the withdrawal phase, compounded by ongoing distributions, can permanently reduce account value even if long-run returns are average.
Question 5: Which of the following is a key difference between tactical and strategic asset allocation?
- Strategic allocation is used only for equity portfolios
- Tactical allocation allows short-term deviations from the strategic target to exploit market opportunities (Correct answer)
- Tactical allocation sets the permanent target weights
- Strategic allocation involves frequent trading based on forecasts
Correct answer: Tactical allocation allows short-term deviations from the strategic target to exploit market opportunities
Tactical asset allocation involves making short-term, opportunistic adjustments away from the long-term strategic target in response to market conditions.
Question 6: An IAR is constructing a portfolio for a client who cannot tolerate any loss of principal. Which investment vehicle is most consistent with this constraint?
- Growth equity mutual fund
- FDIC-insured certificates of deposit (Correct answer)
- Corporate high-yield bond fund
- Emerging market stock ETF
Correct answer: FDIC-insured certificates of deposit
FDIC-insured CDs guarantee return of principal up to the insurance limit, making them the most appropriate option for a client with zero principal loss tolerance.
Question 7: A client wants income from their portfolio but also wants to keep pace with inflation over a 20-year horizon. Which combination best addresses both needs?
- 100% short-term Treasury bills
- Dividend-paying equities combined with inflation-linked bonds (TIPS) (Correct answer)
- Long-term fixed-rate corporate bonds only
- Money market funds and cash equivalents
Correct answer: Dividend-paying equities combined with inflation-linked bonds (TIPS)
Dividend-paying equities provide growing income over time, while TIPS preserve purchasing power against inflation, together addressing both the income and inflation-protection objectives.
IAR Client Investment Recommendations & Strategies 4
Under the prudent investor standard, an IAR managing a discretionary account must evaluate investments primarily based on: