Competency 18 Section 2 Flashcards
- With asset dedication, fixed income needs can be met with constant-maturity bond mutual funds.
False. Asset dedication suggests using specific bonds held to their maturity date to target upcoming spending needs. (LO 18-2-1)
- Portfolio volatility should be of little concern when a client is firmly entrenched in the safety zone above the critical path.
True. (LO 18-2-1)
- Asset dedication differs from a buffer zone approach because asset dedication extends beyond cash to consider a wider set of assets for meeting upcoming spending needs.
True. (LO 18-2-1)
- As each year passes, it is advisable to roll the income portfolio forward by another year when the client is in the danger zone below the critical path.
False. Such action will further lock a client into a trajectory of wealth depletion and an inability to meet their lifetime spending objectives. (LO 18-2-1)
- In a Financial Planning Association survey described by Steven Huxley and J. Brent Burns, individual investors identified market volatility as their top investment risk.
False. The top investment risk was outliving savings (64% identified it), followed by not saving enough and then market volatility. (LO 18-2-1)
- A portfolio of dividend stocks is generally more concentrated (largest issues make up a higher percentage of the total portfolio) than a total market portfolio of stocks.
True. (LO 18-2-2)
- Those seeking yield by focusing on bonds with more distant maturity dates face a risk of capital losses when interest rates decline
False. A reduction in interest rates increases the present value of bonds. Longer-term bonds will enjoy a larger gain in value. (LO 18-2-2)
- Two ways to seek higher income from a fixed income portfolio are to shift from corporate bonds to U.S. government bonds, and to shift from short-term bonds to long-term bonds
False. Corporate bonds tend to offer higher yields than same-maturity date U.S. government bonds. (LO 18-2-2)
- Income portfolios are generally less tax efficient than portfolios built from a total returns perspective.
True. (LO 18-2-2)
10.Strategies which increase stock allocations when markets are overvalued and which decrease stock allocations when markets are undervalued have historically had a tendency to support higher sustainable withdrawal rates than strategies with fixed stock allocations.
False. Stock allocations should decrease when valuations are high and vice versa to have this effect. (LO 18-2-3)
11.A client whose assets greatly exceed the present value of their liabilities has the capacity to use a more aggressive asset allocation
True. (LO 18-2-3)
12.Lifecycle strategies which reduce stock allocations in response to age during retirement distribution have a tendency to reduce sustainable withdrawal rates
True. (LO 18-2-3)
13.If assets fall below liabilities, the safety-first approach would suggest to reduce spending plans rather than increase the aggressiveness of one’s stock allocation.
True. (LO 18-2-3)
14.The equity yield curve shows the worst-case cumulative losses over different time horizons.
False. The losses shown in the equity yield curve are annualized, not cumulative. (LO 18-2-4)
15.Buying a put option on a portfolio is a strategy to reduce downside risk.
True. (LO 18-2-4)
16.A collar strategy combines an investment portfolio with purchases of both a put option and a call option on the portfolio.
False. With a collar strategy, one writes or sells a call option, rather than purchasing it, in order to generate revenues to buy a put option. (LO 18-2-4)
17.The minimax principle suggests that asset allocation be guided by what portfolio is expected to provide the best risk-adjusted returns.
False. With the minimax principle, the portfolio is chosen to minimize the maximum amount of losses in the worst-case scenario, not in the average case. (LO 18-2-4)
18.Using financial derivatives for portfolio protection is usually a more valid idea for early in the retirement period, rather than late in the retirement period.
True. (LO 18-2-4)
19.Though the present value of annuitized assets does not show up as part of a client’s financial portfolio, it is still an important component of a client’s asset holdings.
True. (LO 18-2-5)
20.If the annuity payout rate is higher than a client’s desired withdrawal rate from their financial portfolio, then partial annuitization will result in lower sustainability for the remaining financial assets.
False. A higher payout rate means that a lower withdrawal rate may be used from the remaining financial assets to meet the spending objectives of the client. (LO 18-2-5)
21.The present value of guaranteed annuity payments declines as a client ages and their time horizon shortens.
True. (LO 18-2-5)
22.An argument against replacing bonds with SPIAs in a retirement portfolio is that regulators may object to the increased stock allocation observed for remaining financial assets.
True. (LO 18-2-5)
- Which of the following statements about the impact of shifting from lower yield bond into higher yield bond investments is least likely to be correct? (LO 18-2-2)
A. It can increase the credit risk of the portfolio.
B. It can extend the duration of the income portfolio.
C. It can decrease the tax efficiency of the portfolio.
D. It can reduce the volatility of the portfolio.
- Which of the following statements concerning the income portion of the portfolio with the asset dedication approach is (are) correct? (LO 18-2-1)
I. Term certain annuities could be used to meet the client’s income needs using the asset dedication approach.
II. Bond funds are commonly used to meet the client’s income needs using the asset dedication approach.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
- The answer is A. Statement II is incorrect. Bond funds cannot be used to lock in specific income needs with the same specificity of individual bonds.
- Which of the following statements about research results of the valuation based asset allocation approach is (are) correct? (LO 18-2-3)
I. A Kitces study showed that increasing equity exposure by 20 percent whenever market valuations rise sufficiently will increase the SAFEMAX (safe withdrawal rate).
II. Robert Shiller demonstrated that the price divided by average real earnings over the previous 120 months (PE10) can provide reasonable predictive power for long-term real stock market returns.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
- The answer is B. Statement I is incorrect. Kitces found that decreasing equity exposure when market values rise will increase the safe withdrawal rate
- Which of the following statements about using derivatives with a retirement portfolio is (are) correct? (LO 18-2-4)
I. Put options create downside protection but can be expensive.
II. The best, most cost effective time to use a derivative strategy in a retirement portfolio is early in retirement.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
- The answer is C. Both statements are correct
- Which of the following statements about partial annuitization and the portfolio failure rate is (are) correct? (LO 18-2-5)
I. If the annuity payout rate is higher than the desired withdrawal rate, then annuitization can clearly increase sustainability.
II. If the equity allocation is increased after purchasing an annuity, the impact on sustainability depends on assumptions about asset returns.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
- The answer is C. Both statements are correct
- All of the following statements concerning the critical path and the asset dedication strategy are correct EXCEPT (LO 18-2-1)
A. The critical path is based on the client’s current financial situation, goals, and anticipated financial needs.
B. Comparing the client’s current situation to the critical path identifies when changes are required to the portfolio.
C. Portfolio volatility should be of little concern when a client is firmly entrenched in the safety zone above the critical path.
D. The critical path investment goals are tied to benchmark indexes such as the S&P 500 index
- The answer is D. The critical path investment goals are tied to meeting the client’s own specific income needs
- All of the following are common approaches to dynamic asset allocation decision making in retirement EXCEPT (LO 18-2-3)
A. Lifecycle asset allocation theory
B. The “minimax” theory
C. Valuation based asset allocation
D. Adaptive asset allocation in which stock allocation relates to funding status
- The answer is B. The minimax theory is not an approach to dynamic reallocation; it is a philosophy for selecting investments that tries to minimize the worst case scenario
- Which of the following statements concerning approaches for providing downside portfolio protection is (are) correct? (LO 18-2-4)
I. Including more asset classes can allow for different portfolio characteristics and potentially a portfolio with better return/volatility characteristics.
II. The “MINIMAX” philosophy focuses on trying to improve average investment returns.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
- The answer is A. B is incorrect since the MINIMAX philosophy focuses on improving the worst case scenario
