NASAA Series 65, Uniform Investment Adviser Law ExaminationClient Investment Recommendations and StrategiesEasy
An investment adviser is constructing a portfolio for a client who is highly risk-averse and seeks capital preservation above all else. The client specifically states they cannot tolerate any loss of principal. Which of the following investments would be most suitable?
- AA diversified portfolio of blue-chip stocks.
- BA balanced mutual fund with a 60/40 stock/bond allocation.
- CA certificate of deposit (CD) held to maturity.
- DA long-term municipal bond fund.
Show answer & explanationAnswer & explanation
Correct answer: C. A certificate of deposit (CD) held to maturity.
For a highly risk-averse client whose primary goal is capital preservation and who absolutely cannot tolerate any loss of principal, a Certificate of Deposit (CD) held to maturity is the most suitable option. CDs offer FDIC insurance up to limits, guaranteeing principal if held to maturity.
Why the other options are wrong
- A. Blue-chip stocks, while generally stable, are still equities and carry market risk, meaning principal can be lost.
- B. A balanced mutual fund with a 60/40 stock/bond allocation still exposes the client to significant market risk and potential principal loss from the equity portion.
- D. Long-term municipal bond funds are subject to interest rate risk and market risk, which can lead to principal loss if sold before maturity under rising rates.
Capital Preservation
An investment objective focused on protecting the initial investment amount from loss, often prioritizing safety and liquidity over growth.
- Primary goal is to avoid loss of principal.
- Typical investments include cash, CDs, T-bills.
- Returns are generally low.
- Suitable for very risk-averse investors or short-term needs.
Memory trick: Objectives guide the journey: preserve, grow, or earn income.