- Which of the following statements is TRUE regarding the information an adviser should gather when the client is the trustee of an irrevocable trust?
Answer: The adviser should obtain the trust instrument and the beneficiaries' needs, because those are the primary inputs to the investment strategy.
An adviser's fiduciary duty requires a reasonable basis for recommendations, which for a trust account begins with the terms of the trust and the interests the trustee must serve. The adviser should obtain the trust instrument, which establishes the trustee's investment authority and any distribution restrictions, and should gather information about the beneficiaries' current and future needs, since those needs define the liquidity, time horizon, and risk posture of the portfolio. The trustee's personal objectives are the wrong input because the trustee acts for the beneficiaries, not for herself. The grantor of an irrevocable trust no longer controls the assets, so the grantor's current objectives do not govern. Limiting the inquiry to the trust document omits the beneficiaries' actual needs, which are essential to a suitable strategy.
- Which of the following statements regarding the financial data an adviser gathers about a client's situation is TRUE?
Answer: Cash flow measures the ability to meet obligations and save over a period, while net worth measures accumulated position at a date.
A client's financial situation is described by two different statements. Cash flow tracks income and outlays over a period and shows whether the client can meet obligations and save; net worth is a point-in-time snapshot of assets minus liabilities. They are not the same measure, and net worth is not the right measure of monthly affordability, since assets are not spendable income and may be illiquid. Personal-use assets such as a home are included in net worth even though they are not liquid; they are separated only in a liquidity analysis. Net worth is accumulated position; cash flow is the flow that funds new commitments.
A client, age 52, tells an IAR that he will need $100,000 per year in retirement at age 65. The client currently earns $140,000 per year and estimates his current annual spending at $110,000. The client's mortgage will be paid off by retirement, but he plans to increase his travel spending.
Which of the following is the most appropriate way for the IAR to quantify this client's retirement income goal? Answer: Build the goal from current spending, adjust for the mortgage payoff and planned travel, and confirm the result with the client
A financial goal should be quantified from the client's actual spending rather than accepted at face value or taken from a rule of thumb. The IAR should build the estimate from the client's current spending, remove the mortgage that will be paid off, add the planned travel costs, and confirm the revised figure with the client. Accepting the client's $100,000 estimate skips the analysis and may build the plan on a guess. The 80% replacement-ratio figure is a rough planning shortcut, not a substitute for a spending-based estimate. Using current spending as the final figure ignores the specific changes the client identified.
An IAR is updating a client's financial profile. The client, age 62, provides the following information: a home valued at $800,000 with a $250,000 mortgage; a $420,000 401(k); an $80,000 Roth IRA; $45,000 in a checking account; a car worth $35,000 with a $25,000 auto loan; $18,000 in credit card debt; a $250,000 term life insurance policy with no cash value; and an expected inheritance of $200,000 when the client's parent passes away.
What is the client's current net worth? Answer: $1,087,000
Net worth is current assets minus current liabilities, the standard summary of a client's financial situation. Assets total $1,380,000: the $800,000 home, $420,000 401(k), $80,000 Roth IRA, $45,000 checking account, and $35,000 car. Liabilities total $293,000: the $250,000 mortgage, $25,000 auto loan, and $18,000 credit card debt, leaving a net worth of $1,087,000. The $1,337,000 figure adds the $250,000 term death benefit, but a term policy has no cash value and is not an asset. The $502,000 figure counts only financial assets ($545,000) minus financial debts ($43,000), improperly excluding the home and car. The $1,287,000 figure adds the $200,000 expected inheritance, which is not a current asset.
A client, age 38, is self-employed with variable monthly income. The client's essential monthly expenses are $6,000, and the client has $18,000 in a high-yield savings account. A standard planning guideline is to hold three to six months of essential expenses in liquid reserves, and six to twelve months when income is variable. The client has no other liquid assets.
Based on the client's situation, which of the following statements is most accurate? Answer: The client should hold between $36,000 and $72,000 in liquid reserves because variable income calls for six to twelve months of essential expenses
Liquidity needs are part of the client's financial situation. For a self-employed client with variable income, the guideline calls for a larger reserve, commonly six to twelve months of essential expenses — here, $36,000 to $72,000. The $18,000 reserve is only three months of essential expenses, so it is below the appropriate level. The three-to-six-month range is the stable-income benchmark and understates the reserve a variable-income client should hold. Investing the reserve in a growth fund defeats its purpose, because emergency funds must remain liquid and stable in value.
- An IAR of a state-registered investment adviser is preparing to make new recommendations for existing clients. Which statement is TRUE regarding the adviser's obligation to keep client information current?
Answer: Before making a new recommendation, the adviser must take reasonable steps to confirm that the information on file is current and must investigate any apparent inconsistency.
An investment adviser's fiduciary duty requires a reasonable basis for each recommendation, and that basis depends on current, reasonably complete client information. Before making a new recommendation, the adviser must take reasonable steps to confirm the information on file is current and must follow up on any apparent inconsistency. Waiting passively for the client to report changes is wrong because the duty of inquiry rests on the adviser, and a stale file will not support a recommendation. Independent verification of every income, expense, and net worth figure is also wrong: the standard is reasonable inquiry, not an audit, and consistent client-supplied information may be relied upon. Reviewing account statements alone does not update goals, income, liabilities, family circumstances, or risk tolerance, so it cannot satisfy the updating obligation.
An IAR is developing a retirement plan for a client, age 50, who plans to retire at age 65. The client wants retirement income of $100,000 per year in today's dollars. The client expects to receive $40,000 per year from Social Security and a $30,000 per year pension, both stated in today's dollars. The IAR assumes inflation of 3% per year between now and retirement.
Approximately how much annual income, in future dollars, must the client's investment portfolio provide in the first year of retirement? Answer: $46,700
This item tests quantifying a financial goal in future dollars, a time-value-of-money application. The client's current-dollar income gap is $100,000 − $40,000 − $30,000 = $30,000 per year. Inflating that gap at 3% for 15 years gives $30,000 x (1.03)15 = about $46,700, the amount the portfolio must provide in the first retirement year. The $155,800 figure inflates the full $100,000 goal and ignores Social Security and the pension. The $30,000 figure is the current-dollar gap with no inflation adjustment. The $93,500 figure inflates the gap after Social Security only, omitting the pension. A client, age 55, owns a closely held manufacturing business valued at $2.5 million. The client has $120,000 in liquid investments, a $400,000 401(k), and no debt. The client wants to retire in 10 years and expects to fund retirement by selling the business. The IAR is assessing the client's financial situation.
Which of the following statements best describes how the IAR should treat the business in the client's financial profile? Answer: Treat the business as a concentrated, illiquid asset whose value and salability are uncertain, and weigh that risk in the plan
Assessing a client's financial situation requires distinguishing net worth from liquidity. A closely held business is typically illiquid: its value depends on finding a buyer, and a sale can take years, so the IAR should treat it as a concentrated, non-marketable asset and test the retirement plan against a delayed sale or a lower sale price. Treating it as a liquid asset overstates the client's ability to fund retirement. Excluding it ignores the client's largest asset and the fact that the retirement plan depends on it. Recommending an immediate sale overreaches; the IAR should assess and discuss options, not dictate a sale.
A new client, age 45, has $200,000 to invest and tells the IAR to "pick something good." The client provides his age, income, and employment information, but when the IAR asks about his other assets, liquidity needs, and risk tolerance, the client says those details are private and he does not want to discuss them.
Under the suitability obligations that apply to investment adviser representatives, what should the IAR do? Answer: Decline to make an investment recommendation until the client provides sufficient information about his situation and objectives, and document the refusal
Under the NASAA Unethical Business Practices of Investment Advisers Model Rule, an IAR must not make a recommendation without a reasonable basis, and that basis must rest on inquiry into the client's financial situation, investment objectives, and needs. Because this client refused to provide information about other assets, liquidity needs, and risk tolerance, the IAR lacks a reasonable basis for a recommendation and should decline to make one, documenting the client's refusal. Proceeding with a balanced fund because the client delegated the decision does not supply the missing profile information. Selecting a money market fund is also an investment decision that requires a reasonable basis, and capital preservation may not match the client's objectives. A signed acknowledgment cannot waive the IAR's suitability duty.
- A client tells her investment adviser that she saves $1,500 a month, but the cash-flow data the adviser gathered from her show monthly savings of about $400. Which of the following statements regarding the adviser's use of this conflicting client information is true?
Answer: The adviser should present the discrepancy to the client and resolve it before making a recommendation, because a recommendation must be based on accurate client information.
Under the fiduciary duty owed by investment advisers to their clients, a recommendation must be based on accurate and reasonably complete client information. When the client's stated savings figure conflicts with the gathered cash-flow data, the adviser must raise the discrepancy with the client and reconcile it before relying on either figure. Treating the client's stated figure as controlling adopts an unverified assertion that the adviser's own analysis contradicts. Treating the cash-flow data as controlling assumes the data are complete and correctly classified, but they were supplied by the same client and may be incomplete. Documenting both figures and proceeding on the more conservative figure is also an assumption: conservatism does not make the data accurate, and the conservative figure may not reflect the client's actual goals.
An IAR is gathering information for a 60-year-old client who has $400,000 in a 401(k) and $150,000 in a taxable brokerage account. The client wants tax-deferred growth and guaranteed lifetime income beginning at age 70. The IAR is considering recommending a variable annuity funded with $100,000 from the brokerage account.
Which additional fact about the client is most important for the IAR to determine before making this recommendation? Answer: Whether the client has an emergency fund separate from the $150,000 brokerage account
Under the fiduciary suitability standard, an IAR must weigh a client's liquidity needs before recommending an illiquid product. A variable annuity is subject to surrender charges and is not a source of emergency cash. If the $150,000 brokerage account is also the client's only emergency fund, funding the annuity with $100,000 would leave only $50,000 for all other liquidity needs, so the IAR must first learn whether a separate emergency reserve exists. Marital status affects annuity settlement options but not the threshold liquidity question. The expected retirement tax bracket bears on the value of tax deferral but does not test the client's ability to tie up the money. The client's intentions for heirs affect beneficiary designations, not the liquidity analysis.
A client, age 40, wants to buy a home in three years and estimates she will need $90,000 for the down payment and closing costs. She currently has $25,000 in a savings account and saves $1,500 per month. She has no other savings, and her $80,000 401(k) is earmarked for retirement. Assume her savings account earns no return over the three-year period.
Which of the following most accurately describes the client's situation and the appropriate planning response? Answer: The client faces an $11,000 shortfall, so she should save more, reduce her goal, or extend the timeline.
Quantifying the goal requires comparing the $90,000 target with the client's savings capacity. Over 36 months she would have $25,000 + ($1,500 × 36) = $79,000, leaving an $11,000 shortfall, so the appropriate planning response is to save more, reduce the down-payment goal, or extend the timeline. An aggressive growth fund is unsuitable for a three-year down-payment goal because of the principal risk over that horizon. Using the 401(k) as a backup would undermine the separately earmarked retirement goal and may carry taxes and penalties. The statement that continuing the current plan totals $90,000 misstates the arithmetic.
An IAR is opening an account for an irrevocable trust created by a grandfather for his 10-year-old granddaughter. The trust pays for the granddaughter's education until she reaches age 25 and then distributes the remaining principal to her at age 30. The girl's mother is the trustee and will make all investment decisions with the IAR.
Under the adviser's know-your-client obligations, which of the following should the IAR do when gathering information for this account? Answer: Review the trust instrument to determine the trust's purpose, distribution schedule, and the trustee's investment authority
Under the adviser's know-your-client obligation, the client for a trust account is the trust acting through its trustee, so the IAR must review the trust instrument to understand the trust's purpose, distribution schedule, and the trustee's investment authority; those terms define the appropriate time horizon, liquidity, and risk profile. Gathering the mother's personal income and risk tolerance substitutes the trustee's personal situation for the trust's needs. Gathering the granddaughter's goals treats the beneficiary as the client even though the trustee directs the account. Gathering the grandfather's financial information is misplaced once the trust is funded, because the grantor's personal finances do not define the trust's objectives.
- Which of the following statements regarding the identification and prioritization of client financial goals is TRUE?
Answer: Each goal should be quantified, given a time horizon, and ranked by the client so it can be tested against savings capacity.
An investment adviser's fiduciary duty requires recommendations that fit the client's own objectives, so the client, not the adviser, must define and prioritize the goals. Each goal should be quantified, given a time horizon, and ranked by the client, and the resulting funding needs should be tested against the client's savings capacity. Projecting goals only in current dollars and adjusting for inflation only on request is wrong because long-term goals must be measured in the dollars in which they will be paid. Needs-versus-wants classification can be a useful discussion tool, but the adviser may not unilaterally classify the goals or fund every need before every want. Giving automatic priority to the nearest-dated goal imposes the adviser's ranking instead of the client's choice when capacity is short.
- A client declines to provide information the adviser has requested during the data-gathering process. Which statement is TRUE?
Answer: If the missing information is material to the proposed recommendation, the adviser should not recommend until the client supplies it.
An investment adviser must have a reasonable basis for each recommendation, and that basis requires the client-specific information needed to evaluate it. If the client refuses to supply information that is material to the recommendation, the adviser lacks the basis to make it and should not proceed until the information is obtained. Documenting the refusal and proceeding regardless fails the reasonable-basis requirement. A written acknowledgement signed by the client does not cure the gap, because a client cannot waive the adviser's duty to have a reasonable basis for the recommendation. Filling material factual gaps with assumptions is also improper: assumptions are appropriate for projections such as inflation or returns, not for the client's actual financial facts.
