20 Client Profile & Portfolio Management Practice Questions & Answers

1. 1. Two colleagues are forming a business that will open an advisory account. They want each owner's exposure to business debts capped at what that owner contributed, and they want profits reported on the owners' individual returns with no entity-level tax by default. Which structure satisfies both requirements?

   • A.A limited partnership in which both owners act as general partners and share management duties
   • B.A C corporation, because it shields both owners and passes all earnings through untaxed
   • C.A general partnership, because each partner's liability is capped at his capital account
   • D.A limited liability company whose members have made no election to be taxed as a corporation✓ Answer

   An LLC gives every member limited liability while defaulting to pass-through taxation, so profits land on the members' own returns unless the LLC affirmatively elects corporate treatment. A general partnership provides no liability shield at all; in a limited partnership the general partners remain personally liable without limit, and here both owners would be general partners; and a C corporation does shield its owners but is the one structure taxed at the entity level and taxed again when earnings are distributed as dividends.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), client types — business entities; Uniform Limited Liability Company Act; IRS entity classification (check-the-box) regulationsReport a problem with this question

2. 2. A family business taxed as an S corporation wants to admit a new investor: an investment partnership that would receive newly issued shares carrying a preferred claim on distributions. The company's adviser warns that this would end its pass-through status. Which limitation on S corporations supports that warning?

   • A.All earnings must be distributed each year, or the corporation is taxed on whatever it retains
   • B.Shareholders must be individuals or certain trusts, and only one class of stock may be outstanding✓ Answer
   • C.Shareholders are limited to ten, with each partner in an owning partnership counted separately
   • D.Pass-through treatment is forfeited whenever a shareholder is not also an employee of the business

   An S corporation election survives only if every shareholder is an eligible holder — generally a U.S. individual, an estate or a qualifying trust — and the company has just one class of stock. The proposed deal breaks both rules at once: a partnership is not an eligible shareholder, and shares with a preferred claim on distributions create a second economic class. Differences in voting rights alone would not create a second class, and the shareholder ceiling is far above ten, so those distractors misstate the limits.

   Source: Internal Revenue Code Section 1361 (S corporation eligibility: permitted shareholders and one-class-of-stock rule); NASAA Series 65 Test Specifications (effective June 12, 2023), client types — business entitiesReport a problem with this question

3. 3. An adviser manages a trust that pays all income to the grantor's surviving spouse for life, with whatever remains passing to the grantor's children at her death. The spouse asks for more current income, while the children object that the portfolio is barely growing. What should guide the trustee's allocation decision?

   • A.Poll the income beneficiary and the remaindermen and adopt the allocation that a majority of them prefer
   • B.Follow the trust instrument and the prudent investor standard, balancing both classes of beneficiary✓ Answer
   • C.Shift toward high-yield bonds and preferred stock, because the income beneficiary holds the present interest
   • D.Emphasize growth equities and defer income, because preserving principal for the remaindermen comes first

   A trustee's authority comes from the trust document, and where that document is silent the prudent investor standard requires the trustee to act impartially between an income beneficiary and a remainderman and to judge prudence at the level of the whole portfolio rather than holding by holding. That normally produces a balanced allocation that funds current income without starving long-term growth. Neither class of beneficiary automatically outranks the other, and beneficiaries do not vote on how trust assets are invested.

   Source: Uniform Prudent Investor Act Sections 2 and 6 (portfolio-level prudence and duty of impartiality); NASAA Series 65 Test Specifications (effective June 12, 2023), client types — trustsReport a problem with this question

4. 4. A charitable foundation that pays no federal income tax asks its adviser to construct the fixed-income portion of its endowment. A junior colleague proposes filling that sleeve with high-grade general obligation municipal bonds. What is the strongest objection to the proposal?

   • A.The foundation owes no federal income tax, so it gives up yield for a benefit it cannot use✓ Answer
   • B.The tax-exempt interest would become taxable to donors when the foundation makes its grants
   • C.A charitable organization is legally barred from holding municipal securities in its endowment
   • D.Municipal bonds carry more default risk than corporate bonds carrying the same credit rating

   Municipal bonds yield less than comparable taxable bonds precisely because their interest escapes federal income tax; buyers accept the lower coupon in exchange for the exclusion. A client that owes no federal income tax — a foundation, a church, a charity — pays that lower yield and receives nothing back for it, so taxable corporate or Treasury paper of comparable quality is the better fit. The objection is economic, not legal: nothing prohibits a charity from owning municipal bonds, and the same mismatch is why municipals do not belong in tax-deferred accounts.

   Source: Internal Revenue Code Section 103 (exclusion of interest on state and local bonds); NASAA Series 65 Test Specifications (effective June 12, 2023), client types — foundations and charitable organizationsReport a problem with this question

5. 5. A married couple opens a joint advisory account that both will fund and both will sign for. During the profiling meeting one spouse states an aggressive growth objective while the other describes a strong preference for preserving principal. How should the adviser proceed?

   • A.Divide the account internally into two sleeves and manage each one to a single spouse's objective
   • B.Document the objectives the couple agrees on, managing to the more conservative profile meanwhile✓ Answer
   • C.Manage to the aggressive spouse's profile, since either joint owner may direct the entire account
   • D.Average the two stated risk tolerances and manage to the midpoint allocation that results

   A joint account has one investment profile, not two, because every recommendation must be suitable for the account as a whole and therefore for both owners. The adviser cannot simply follow whichever owner speaks loudest, run an informal split that neither the contract nor the account registration reflects, or mechanically average two tolerances into an allocation that fits neither. The professional step is to reconcile the objectives in conversation, document what the owners agree on, and manage to the more conservative of the two profiles until that agreement exists.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), client profile — financial goals and objectives, risk tolerance; Investment Advisers Act of 1940 Section 206 (fiduciary duty)Report a problem with this question

6. 6. A 34-year-old client has secure employment, six months of living expenses in cash, no debt and no need to touch this money before retirement. He tells his adviser that any quarter showing a loss keeps him awake at night and asks to put the entire account in short-term certificates of deposit. Which statement best describes his situation?

   • A.His ability to take risk is high but his willingness is low, and the plan must respect the lower of the two✓ Answer
   • B.His long horizon outweighs his stated discomfort, so a mostly equity allocation should be recommended
   • C.His willingness and his ability to take risk are both low, so an all-cash portfolio is the suitable result
   • D.Willingness and ability describe the same trait, so his own statement settles the allocation question

   Risk capacity is the objective ability to absorb a loss — horizon, income stability, reserves, net worth — and this client's is high. Risk tolerance is the subjective willingness to live through one, and his is low. When the two diverge, the adviser educates the client but builds the portfolio toward the more conservative of the two, because an investor who abandons the plan during a drawdown converts a paper loss into a permanent one. That is not the same as endorsing an all-cash portfolio, which would expose a thirty-year horizon to purchasing-power risk.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), client profile — risk tolerance and time horizon; Investment Advisers Act of 1940 Section 206Report a problem with this question

7. 7. A client age 52 invests a lump sum she will not spend until she retires at 67, but she also wants to be able to draw on the account for an unexpected medical bill without having to sell at a depressed price. Which description of her constraints is correct?

   • A.A 15-year horizon and no liquidity constraint, because retirement money is illiquid by definition
   • B.A short time horizon, because the chance of an early withdrawal shortens the horizon to the present
   • C.A liquidity need alone, since time horizon applies to withdrawal plans rather than lump-sum deposits
   • D.A 15-year time horizon together with a liquidity need a cash reserve inside the plan should cover✓ Answer

   Time horizon is when the money is needed for its stated purpose; liquidity is how quickly some portion can be converted to cash without a meaningful loss of value. They are separate constraints and a single portfolio can face both at once. The standard solution is to carve out a segregated cash or short-duration reserve sized to the possible medical bill and invest the remainder for the fifteen-year horizon, rather than letting the possibility of one emergency shorten the effective horizon of the whole account.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), client profile — time horizon and current and future financial situationReport a problem with this question

8. 8. A client will not sell a stock trading far below what she paid, saying she will let it go the moment it gets back to her cost, yet she sells other holdings as soon as they show a modest gain. Which pair of behavioral tendencies best describes this?

   • A.Anchoring on her purchase price together with loss aversion, the disposition effect✓ Answer
   • B.Confirmation bias in the research she reads together with excessive portfolio turnover
   • C.Recency bias about the latest returns together with mental accounting of separate goals
   • D.Overconfidence in her own stock picking together with herding into consensus positions

   Anchoring is fixation on a reference number that carries no information about the future — here, the price she happened to pay. Loss aversion, visible as the disposition effect, is the tendency to hold losing positions to avoid realizing a loss while selling winners early to lock in a gain. The adviser's job is to name the behavior and steer the client back to the plan: whether to hold or sell should turn on the security's outlook and the portfolio's targets, never on the client's original cost.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), client profile — nonfinancial investment considerations, including behavioral financeReport a problem with this question

9. 9. A client directs her adviser, on religious grounds, to exclude any company deriving meaningful revenue from alcohol, tobacco or firearms, even though the screen narrows the investable universe. What is the appropriate response?

   • A.Accept the restriction in conversation but override it whenever a screened company looks clearly better
   • B.Record the restriction in her profile and invest within it, disclosing the effect on diversification✓ Answer
   • C.Decline the mandate, because screening out whole industries conflicts with the duty to diversify
   • D.Apply the screen only to new purchases and leave any existing screened positions in place indefinitely

   The current test specifications list a client's values — environmental, social, governance and religious criteria — among the nonfinancial considerations that belong in the client profile. A client is entitled to restrict the adviser's discretion; once imposed, the restriction is part of the mandate, so the adviser documents it, invests within it, and discloses its consequences, including reduced diversification and tracking differences against a broad benchmark. Quietly overriding a client restriction would breach both the advisory contract and the fiduciary duty of loyalty.

   Source: NASAA Series 65 Test Specifications (effective June 12, 2023), client profile — nonfinancial investment considerations (values, including environmental, social, governance and religious criteria); Investment Advisers Act of 1940 Section 206Report a problem with this question

10. 10. Assume the risk-free rate is 4% and the expected return on the broad market is 9%. A stock has a beta of 0.8. Under the capital asset pricing model, what return should an investor require from this stock?

    • A.11.2%
    • B.7.2%
    • C.9.0%
    • D.8.0%✓ Answer

    CAPM adds a risk premium to the risk-free rate: required return = risk-free rate + beta x (market return - risk-free rate) = 4% + 0.8 x (9% - 4%) = 4% + 4.0% = 8.0%. The market risk premium is the 5% spread, not the 9% market return, so multiplying beta by 9% gives 7.2% and adding that product to the risk-free rate gives 11.2%, both of which misapply the model; 9.0% simply ignores beta. A beta below 1.0 means the stock should be required to earn less than the market, because beta prices only systematic risk.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), capital market theory — capital asset pricing modelReport a problem with this question

11. 11. An analyst is deciding whether one particular common stock is priced fairly for the amount of non-diversifiable risk it carries. Which line should she plot it against, and which risk measure belongs on that line's horizontal axis?

    • A.The capital market line, with the stock's beta and the market risk premium
    • B.The security market line, with the stock's beta measured against the market✓ Answer
    • C.The efficient frontier, with the stock's correlation to the overall market
    • D.The capital market line, with the standard deviation of the stock's returns

    The security market line comes out of CAPM and plots required return against beta, the measure of systematic risk, so it applies to any individual security as well as to portfolios: a stock plotting above the line earns more than its beta demands, which is positive alpha and suggests it is undervalued, while one below the line is not paying for the risk taken. The capital market line uses total risk — standard deviation — and describes only efficient portfolios that blend the risk-free asset with the market portfolio, so it is the wrong tool for judging one stock.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), capital market theory — capital asset pricing model and modern portfolio theoryReport a problem with this question

12. 12. An adviser is convinced that every piece of publicly available information — earnings releases, analyst research, the entire price history — is already reflected in stock prices, though he believes non-public information is not. Which course of action follows most directly from that conviction?

    • A.Build portfolios from low-cost index funds, since neither chart work nor fundamental research adds value✓ Answer
    • B.Assume no investor of any kind can outperform, including corporate insiders trading on private facts
    • C.Trade actively on valuation screens, since prices are demonstrably inefficient in nearly every respect
    • D.Use fundamental analysis of financial statements, since only technical analysis has been rendered useless

    That description is the semi-strong form of the efficient market hypothesis: all public information is already in the price, so technical analysis (already ruled out by the weak form) and fundamental analysis of public disclosures both fail to produce reliable excess returns, while private information still could. An investor who accepts it manages passively — indexing, low turnover, low cost — because paying for security selection buys nothing. Only the strong form claims insiders cannot outperform, and that form has the least empirical support.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), capital market theory — efficient market hypothesisReport a problem with this question

13. 13. A client holds sixty stocks spread across a dozen industries and calls her adviser after a broad market decline to ask why her diversified portfolio still lost roughly what the index lost. What is the best explanation?

    • A.Her positions must be unusually correlated with one another, so she is not truly diversified
    • B.Diversification only works over multi-year periods and offers nothing during a short decline
    • C.Diversification removes company-specific risk, but market risk reaches every stock and remains✓ Answer
    • D.Sixty holdings is too few; a portfolio needs roughly two hundred names to remove market risk

    Diversification works by combining assets whose company-specific, unsystematic risks are imperfectly correlated, and most of that benefit is captured well before a portfolio reaches sixty holdings. Systematic risk — market, interest-rate, inflation and other economy-wide exposures — is common to all equities and cannot be diversified away; reducing it requires shifting asset classes or hedging, not adding more stocks. A broadly diversified equity portfolio should therefore be expected to fall with the market in a general decline.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), capital market theory — modern portfolio theory; Uniform Prudent Investor Act Section 3 (diversification)Report a problem with this question

14. 14. A client's long-term policy sets a 60% equity and 40% fixed-income target. After a strong year for stocks the account stands at 72% equity, and the client says she would rather let the winners run. What does a strategic asset allocation discipline call for?

    • A.Leaving the mix alone and directing all new contributions into equities
    • B.Moving to cash until equity valuations return to their long-run average
    • C.Selling equities and buying fixed income to restore the 60/40 mix✓ Answer
    • D.Raising the equity target to 72% to reflect the new market environment

    Strategic asset allocation fixes long-term target weights derived from the client's objectives and constraints, and it is maintained by rebalancing: selling the asset class that outperformed and buying the one that lagged. It feels backwards, which is exactly why it is tested — leaving a 72% equity weight in place quietly raises portfolio risk above what the client's profile supports. Redirecting new contributions only slows the drift, raising the target abandons the policy, and moving to cash is market timing rather than rebalancing.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio management strategies — strategic asset allocation and rebalancingReport a problem with this question

15. 15. An adviser who normally holds his clients' policy weights cuts equity exposure ten percentage points below target because he expects an economic slowdown, and states that he will restore the target weights afterward. How is this activity best described?

    • A.Rebalancing, because the portfolio is being pulled back toward its stated long-term targets
    • B.Strategic asset allocation, because the long-term policy weights are what is being applied
    • C.Sector rotation, because exposure is being moved among industries as the cycle turns
    • D.Tactical asset allocation, a deliberate short-term departure from the policy weights✓ Answer

    Tactical asset allocation is an intentional, temporary deviation from the strategic targets meant to exploit a short-term market view, with an explicit intention of returning to the policy weights. Rebalancing is the opposite motion, restoring weights that market movement has pushed off target, and strategic allocation is the policy itself rather than a departure from it. Sector rotation moves money among industries inside an asset class. Tactical shifts add market-timing risk, must stay within the client's stated risk parameters, and require discretionary authority under the advisory contract.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio management strategies — tactical asset allocationReport a problem with this question

16. 16. A client transfers the same dollar amount into the same equity mutual fund on the first business day of every month and intends to continue through both rising and falling markets. Which statement about this program is accurate?

    • A.The program shields her invested principal from loss in a sustained market decline
    • B.Buying a set number of shares each month would produce the same average cost
    • C.The program guarantees a gain provided she keeps investing for at least ten years
    • D.Her average cost per share will come in below the average price per share paid✓ Answer

    Investing a fixed dollar amount at fixed intervals buys more shares when the price is low and fewer when it is high, so the weighted average of what she pays per share falls below the simple average of the prices at which she bought. That arithmetic is the whole benefit of dollar-cost averaging: it guarantees no profit, provides no protection against loss in a falling market, and works only if the investor is both willing and financially able to keep buying through declines. Buying a fixed number of shares instead makes average cost equal average price.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio management techniques — dollar-cost averagingReport a problem with this question

17. 17. A client must pay a known tuition bill in exactly seven years and wants the bond portion of her portfolio arranged so that a change in interest rates between now and then does as little as possible to the amount she will have available. Which approach addresses that directly?

    • A.Hold only money market instruments, because their prices never move with interest rates
    • B.Buy the highest-coupon bonds available, since large coupons repay the investment fastest
    • C.Build a bond portfolio whose duration is set near seven years, matching the liability✓ Answer
    • D.Buy long-maturity bonds, because their higher yields will outrun any rate movement

    Immunization matches the duration of a bond portfolio to the date the money is needed. At that horizon the price risk created by a rate change and the reinvestment risk on the coupons move in opposite directions and largely offset, so the ending value is insulated from rate movements. Maturity alone does not accomplish this, because coupon reinvestment still varies with rates; chasing the highest coupons shortens duration below the target; and rolling money market instruments for seven years leaves the entire sum exposed to falling reinvestment rates.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio management strategies and techniques; standard duration-matching (immunization) methodologyReport a problem with this question

18. 18. A conservative retired client reads about a fund built to deliver twice the daily percentage change of a stock index and asks to make it a core long-term holding. What should the adviser explain?

    • A.The fund resets exposure daily, so long-run results diverge from twice the index✓ Answer
    • B.The fund returns twice the index over any holding period, which suits long-term goals
    • C.The fund removes downside risk, because the leverage applies to index gains only
    • D.The fund's main drawback is its expense ratio, which a long horizon can overcome

    Leveraged and inverse funds reset their exposure every trading day, so results over longer periods reflect compounded daily returns rather than a multiple of the index's cumulative return. In a volatile market without a clear trend, that path dependence can leave a holder far behind twice the index, or even losing money while the index is roughly flat. These are short-horizon trading tools, and recommending one as a core buy-and-hold position for a conservative retiree is unsuitable regardless of how the index eventually performs.

    Source: FINRA Regulatory Notice 09-31 (non-traditional, leveraged and inverse ETFs); NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio management techniques — leveraging and inverse strategiesReport a problem with this question

19. 19. An adviser is comparing the skill of two portfolio managers. One managed an account that received a large deposit shortly before a strong market rally; the other managed an account with no cash flows at all during the period. Which return measure allows a fair comparison of the two managers, and why?

    • A.Internal rate of return, because it discounts all the cash flows to a single figure
    • B.Holding period return, because it covers the full period each account was invested
    • C.Time-weighted return, because it neutralizes the timing and size of client cash flows✓ Answer
    • D.Dollar-weighted return, because it captures every dollar the client actually earned

    A manager controls what the portfolio does, not when the client adds or removes money. The time-weighted return breaks the measurement period at each cash flow and links the sub-period returns together, so the size and timing of client deposits and withdrawals drop out; that is why it is the standard for comparing managers and mutual funds. The dollar-weighted return, which is the internal rate of return of the account's cash flows, measures the investor's own experience and would flatter the manager who happened to receive a deposit just before the rally.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio performance measures — time-weighted and dollar-weighted returns; CFA Institute Global Investment Performance Standards (time-weighted return convention)Report a problem with this question

20. 20. A client's small-capitalization value fund returned less than the S&P 500 last year and she wants to fire the manager immediately. Before responding, what does a sound performance review require?

    • A.Compare the fund's raw return against the average return of all equity funds sold to the public
    • B.Compare the fund against the S&P 500 over five years, since a single year is too short a window
    • C.Compare the fund against a small-cap value index and a risk-adjusted measure such as the Sharpe ratio✓ Answer
    • D.Compare the fund's standard deviation with the index's, since lower volatility settles the question

    A benchmark is informative only when it matches the portfolio's asset class and investment style; measuring a small-cap value fund against a large-cap blend index such as the S&P 500 tests whether small-cap value was in favor, not whether the manager did his job. A sound review uses a small-cap value index, ideally over a full market cycle, together with a risk-adjusted measure — the Sharpe ratio divides return above the risk-free rate by standard deviation — so that a lower raw return earned with materially less risk is recognized for what it is.

    Source: NASAA Series 65 Test Specifications (effective June 12, 2023), portfolio performance measures — risk-adjusted returns and relevant benchmarksReport a problem with this question

Practice questions written from the NASAA Series 65 Test Specifications and the Uniform Securities Act. Not affiliated with or endorsed by NASAA, FINRA or Prometric. Dollar thresholds, fee figures and contribution limits change; where one matters the question supplies it. Confirm current requirements with NASAA before testing. NASAA exam content outline →