NASAA Series 66 Uniform Combined State Law ExaminationClient Investment Recommendations and StrategiesMedium
A client has a portfolio with a target asset allocation of 60% equities and 40% fixed income. Due to a significant rally in the stock market, the current allocation has shifted to 75% equities and 25% fixed income. To bring the portfolio back to its original target, the investment adviser should recommend:
- ASelling both equities and fixed income to reduce overall portfolio size.
- BMaintaining the current allocation to capture further market gains.
- CSelling equities and buying fixed income.
- DBuying more equities and selling fixed income.
Show answer & explanationAnswer & explanation
Correct answer: C. Selling equities and buying fixed income.
To rebalance a portfolio back to its target allocation after equities have outperformed, the adviser should sell a portion of the overweight asset (equities) and use the proceeds to buy the underweight asset (fixed income).
Why the other options are wrong
- A. This action would reduce the portfolio size but would not necessarily bring the asset allocation back to the target without specific ratios for selling.
- B. Maintaining the current allocation means not rebalancing, which deviates from the client's target asset allocation strategy.
- D. This action would further exacerbate the imbalance, moving the portfolio further away from its target.
Portfolio Rebalancing
The process of adjusting a portfolio's asset allocation back to its original or target weights after market movements have caused it to drift.
- Maintains desired risk-return profile.
- Involves selling appreciated assets and buying depreciated assets.
- Can be done periodically (e.g., annually) or when drift exceeds a certain threshold.
- Prevents a portfolio from becoming too risky or too conservative.
Memory trick: When assets drift, rebalance swift, sell high, buy low, to keep the balance flow.