Series 65 Client Profile and Investment Policy Statement Practice Questions
Question 1
A 45-year-old client is saving for her child's college education, which will begin in approximately 15 years. In constructing the investment policy statement for this specific goal, what time horizon should the adviser use?
- A. The client's own life expectancy
- B. Approximately 15 years, measured to when the funds will be needed for that goal
- C. One year, because equity markets should always be evaluated on an annual basis under SEC rules
- D. Indefinite, since education is a lifelong pursuit
Show answer and explanation
Correct answer: B. Approximately 15 years, measured to when the funds will be needed for that goal
Time horizon is goal-specific — it runs from now until the funds are needed for that particular objective, not the client's overall lifespan. A single client can have multiple time horizons for multiple goals (e.g., retirement vs. college funding), each with its own appropriate asset allocation.
- A. Using the client's own life expectancy conflates her personal planning horizon with the specific goal's horizon; the college goal has its own distinct timeline that should drive the IPS for that goal.
- B. Correct. For a goal-specific IPS, the time horizon should be measured to when the funds are actually needed — here, approximately 15 years until college begins — not some other unrelated timeframe.
- C. No SEC rule requires a one-year evaluation horizon for equities; time horizon should match when the goal's funds are needed, which here is roughly 15 years out.
- D. Education funding isn't an indefinite goal for IPS purposes — it has a concrete, foreseeable start date (roughly 15 years away), which is the relevant horizon to plan around.
Question 2
Which client circumstance would most directly increase the liquidity requirement documented in an IPS?
- A. A stable, long-tenured salaried job with predictable annual raises
- B. A high risk-tolerance score on the client's questionnaire
- C. A 30-year time horizon until the client's planned retirement date
- D. An anticipated need for a $40,000 home down payment in 8 months
Show answer and explanation
Correct answer: D. An anticipated need for a $40,000 home down payment in 8 months
Liquidity needs reflect near-term cash requirements. A known $40,000 outlay in 8 months requires the IPS to earmark that amount in liquid, low-volatility assets, distinct from time horizon or risk tolerance, which address different aspects of the client profile.
- A. Stable employment supports financial stability but does not create a near-term cash need that raises liquidity requirements.
- B. Risk tolerance concerns willingness to accept volatility, not a specific near-term cash need.
- C. A long time horizon typically supports lower, not higher, near-term liquidity needs.
- D. A specific, near-term cash need — an $40,000 down payment expected in just 8 months — directly increases the amount of the portfolio that must be kept liquid and readily accessible.
Question 3
A client refuses to sell a losing technology stock, explaining, 'I'll wait until it gets back to what I paid for it,' while readily selling profitable positions to 'lock in the gains.' This pattern of behavior is best described as:
- A. Anchoring bias
- B. Recency bias
- C. The disposition effect
- D. Mental accounting
Show answer and explanation
Correct answer: C. The disposition effect
The disposition effect describes the tendency to sell winning investments too early while holding losing investments too long, hoping to avoid realizing a loss. Anchoring (fixating on the purchase price) is a related but narrower cognitive bias that helps explain why the effect occurs.
- A. Anchoring involves fixating on a reference point like the original purchase price, but the specific pattern of holding losers while readily realizing winners has its own named bias.
- B. Recency bias is overweighting the most recent data or events in forming expectations, not this specific gain/loss selling asymmetry.
- C. This asymmetric treatment of winners and losers — selling winners early to lock in gains while holding losers hoping for breakeven — is the classic disposition effect.
- D. Mental accounting refers to treating money differently based on subjective categories or sources, not this particular win/loss selling pattern.
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When drafting a client's Investment Policy Statement (IPS), an adviser distinguishes between investment objectives and investment constraints. Which of the following is properly classified as a constraint rather than an objective?
- A. Desired long-term total return
- B. Risk tolerance expressed as acceptable volatility
- C. Liquidity needs, such as funds required for a near-term home purchase
- D. Target asset allocation mix
Show answer and explanation
Correct answer: C. Liquidity needs, such as funds required for a near-term home purchase
An IPS separates objectives (what the client wants to achieve, such as return and risk tolerance) from constraints (limitations the portfolio must work within, such as liquidity needs, time horizon, tax considerations, legal/regulatory restrictions, and unique circumstances). Liquidity needs are a textbook constraint: they limit how much of the portfolio can be tied up in illiquid or volatile assets, regardless of the client's stated return or risk objectives.
- A. Wrong: desired return is a primary objective, not a constraint.
- B. Wrong: risk tolerance is the other primary objective in the objectives/constraints framework.
- C. Correct: liquidity needs are a classic constraint, limiting how the portfolio can be structured regardless of return/risk goals.
- D. Wrong: target asset allocation is an output/implementation decision derived from the objectives and constraints, not a constraint itself.