RMA Investment Management & Asset Allocation 3 — Questions and Answers
Question 1: A client in her early 70s wants to hold 100% bonds for safety. Which concept BEST explains why this extreme conservative allocation could actually increase her retirement risk?
- Inflation risk eroding the purchasing power of fixed income returns over a 20+ year horizon (Correct answer)
- Interest rate risk causing immediate mark-to-market losses on her bond portfolio
- Credit risk from corporate bond defaults in a recession
- Reinvestment risk from bond coupon payments
Correct answer: Inflation risk eroding the purchasing power of fixed income returns over a 20+ year horizon
A 100% bond portfolio is highly vulnerable to inflation risk, as fixed income returns may not keep pace with rising prices over a long retirement horizon.
Question 2: The 'bucket strategy' for retirement income management typically divides assets into which groupings?
- Domestic, international, and alternative investments
- Short-term liquidity, intermediate growth, and long-term growth buckets (Correct answer)
- Tax-deferred, tax-free, and taxable accounts
- Equities, fixed income, and cash equivalents
Correct answer: Short-term liquidity, intermediate growth, and long-term growth buckets
The bucket strategy separates assets into a near-term liquidity bucket, a medium-term buffer, and a long-term growth bucket aligned with different time horizons.
Question 3: Which of the following BEST describes a 'liability-matching' approach to retirement portfolio construction?
- Maximizing total return to outperform a benchmark index
- Structuring assets to fund specific anticipated future cash flows (Correct answer)
- Maintaining a fixed 60/40 equity/bond split throughout retirement
- Selecting high-dividend stocks to cover annual living expenses
Correct answer: Structuring assets to fund specific anticipated future cash flows
Liability-matching (or liability-driven investing) aligns portfolio assets with specific projected future liabilities, such as retirement income needs.
Question 4: A client's portfolio has a beta of 1.3. During a year when the market returned -10%, what approximate return would the portfolio be expected to show based solely on beta?
- -7.7%
- -10.0%
- -13.0% (Correct answer)
- -3.0%
Correct answer: -13.0%
Beta of 1.3 means the portfolio is expected to move 1.3 times the market; -10% × 1.3 = -13% expected portfolio return.
Question 5: In the context of retirement asset allocation, 'human capital' is BEST defined as:
- The total value of a client's real estate holdings
- The present value of a client's future earned income from employment (Correct answer)
- A client's accumulated Social Security credits
- The intellectual property owned by a client's business
Correct answer: The present value of a client's future earned income from employment
Human capital represents the present value of future wages and is considered alongside financial capital when determining an appropriate overall asset allocation.
Question 6: Which statement BEST describes the role of alternative investments (e.g., real assets, hedge funds) in a retirement portfolio?
- They always provide higher returns than traditional equity investments
- They can potentially improve diversification by having low correlation to stocks and bonds (Correct answer)
- They are exempt from all tax reporting requirements
- They are required by ERISA in qualified retirement accounts
Correct answer: They can potentially improve diversification by having low correlation to stocks and bonds
Alternatives can reduce overall portfolio volatility and improve risk-adjusted returns when they exhibit low or negative correlation with traditional asset classes.
Question 7: A 72-year-old client asks about adding a 15% allocation to international emerging market equities. What is the PRIMARY concern an RMA adviser should raise?
- Emerging markets pay no dividends and generate no income
- The higher volatility and political risk may be inappropriate given the client's distribution timeline (Correct answer)
- Emerging market investments are prohibited in IRAs under federal law
- International funds always underperform domestic funds over 10-year periods
Correct answer: The higher volatility and political risk may be inappropriate given the client's distribution timeline
For a retiree in distribution phase, the higher volatility and political/currency risks of emerging markets can amplify sequence-of-returns risk.
RMA Investment Management & Asset Allocation 3
A client in her early 70s wants to hold 100% bonds for safety.
Which concept BEST explains why this extreme conservative allocation could actually increase her retirement risk?