A 30-year-old accredited investor with a 35-year horizon and a 65-year-old retiree living on portfolio income both want your advice. Same asset class on the table. Recommending the same thing to both is a suitability violation. Knowing why starts with the client profile.
The exam tests four categories of clients, each with distinct investment constraints.
Individuals are the most common client type. Their needs depend on life stage, income, net worth, tax bracket, and personal goals. An accredited investor (someone with income exceeding $200,000 individually ($300,000 jointly) in each of the past two years, or net worth above $1,000,000 excluding primary residence) has access to private placements under Regulation D. A non-accredited individual does not. The exam often presents a scenario and asks whether the person qualifies as accredited. Remember: primary residence is excluded from the net worth calculation.
TRAP: A client with a net worth of $900,000 including their primary residence does NOT qualify as accredited. Strip out the home value first.
Common mistakes
- Applying CAPM by multiplying beta times total market return. The formula uses beta times the equity risk premium, not beta times the market return. If the risk-free rate is 4% and the market return is 11%, the premium is 7%. A beta-0.6 stock expects 4% + (0.6 x 7%) = 8.2%.
- Confusing risk capacity with risk willingness. Capacity is financial (income, net worth, liquidity, time horizon. Willingness is emotional) comfort with volatility, past behavior during downturns. When a question asks about "ability to take risk," the answer involves financial facts. When it asks about "comfort with volatility," the answer involves psychology.
- Including the primary residence in accredited investor net worth. The $1,000,000 net worth threshold excludes the value of the primary residence. A client with $800,000 net worth plus a $500,000 home has $800,000 for accreditation purposes. The exam uses home values to inflate apparent net worth and tempt you into a wrong qualification.
Bottom line
- Client types: individuals, business entities (C corp, S corp, partnerships, LLCs), trusts (revocable vs. irrevocable), foundations and charities
- Client profile = 5 factors: financial goals, financial situation, risk tolerance (capacity vs. willingness), nonfinancial considerations, time horizon
- Risk capacity is financial ability to absorb losses; risk willingness is emotional comfort with volatility. The lower of the two governs the recommendation
- Accredited investor: $200,000 income ($300,000 joint) for 2 years, or $1,000,000 net worth excluding the primary residence
Exam shortcut
When a CAPM question gives you the risk-free rate, market return, and beta, always isolate the equity risk premium first. The trap answer is beta times the total market return, that skips the subtraction step and will appear as a choice. Risk capacity vs. willingness: "Capacity = Can you afford the loss? Willingness = Can you sleep at night?" When they conflict, go with the more conservative answer.
The full lesson (about 3,208 words, 21 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C19
- C20
- C21
- C22
- C23
- C24
- C25
- C26
- C27
- C28
- C29
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