A 67-year-old retiree with a $2M portfolio and a 32-year-old engineer maxing her 401(k) walk into the same office; recommending the same 80/20 mix to both is malpractice. Suitability runs from the client profile, through capital market theory, to measurable performance.
Every recommendation must rest on a current, documented profile. NASAA (the umbrella body of state securities Administrators whose model rules states adopt to harmonize investor protection) anchors suitability in the client's financial situation, not the rep's intuition. Reg BI extends the same best-interest logic to broker-dealer recommendations to retail clients, because retail investors cannot independently verify whether a complex product fits their needs.
The five mandatory profile elements:
- Financial goals: capital preservation, current income, growth, aggressive growth, speculation. Most clients juggle multiple goals at different priorities.
- Risk tolerance: willingness and ability to absorb loss. Willingness is psychological. Ability is mathematical (income, net worth, time horizon).
- Time horizon: when the money is needed. A 30-year horizon tolerates equity volatility; a 2-year horizon does not.
Common mistakes
- Recommending before profiling. Suitability requires the profile first. A rep who says "I have a great muni fund, what's your tax bracket?" has the order backward. The exam answer is always: gather the profile, then recommend.
- Confusing time-weighted and dollar-weighted returns. Candidates pick TWR when the question asks "what did the client earn", wrong, that's DWR/IRR. They pick DWR when comparing two managers, wrong, client cash flows muddy the comparison. TWR for manager skill, DWR for client experience.
- Treating "diversification" as "many holdings." A portfolio of 50 tech stocks is not diversified: they share systematic and sector-specific risk. True diversification requires low or negative correlation across asset classes (stocks, bonds, real assets, international). Counting positions is not the test.
Bottom line
- Suitability requires goals, risk tolerance, time horizon, tax status, and liquidity needs, gathered before any recommendation and documented in writing.
- MPT diversifies away unsystematic risk via low-correlation assets; the efficient frontier maximizes return per unit of risk, and CAPM prices only remaining systematic risk (beta).
- EMH has three forms: weak (price history useless), semi-strong (public info priced in), strong (insider info priced in); the strong form is empirically rejected.
- Time-weighted return measures manager skill (excludes client cash flows); dollar-weighted return (IRR) measures the client's actual experience.
Exam shortcut
Profile-then-recommend, never the reverse. When a question asks what the rep should do first, the answer is almost always "complete the suitability profile" or "gather more information." Recommendation answers come second. TWR for managers, DWR for clients. If the question is about comparing funds or rating a manager, pick time-weighted. If the question is what a specific client earned, pick dollar-weighted (IRR). The verb in the question ("compare" vs.
The full lesson (about 3,447 words, 23 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C10
- C11
- C12
- C13
- C14
- C15
- C16
- C17
- C18
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