Identifying suitable investments is part art, part science. You need to understand product characteristics, investor profiles, investment objectives, and risk tolerance. The topics covered in earlier suitability chapters represent the “science” behind the concept. Here, we’ll focus on the “art”: how to work through suitability questions the way the exam expects.
This chapter doesn’t introduce new test topics. Instead, it helps you apply what you already know so you can consistently choose the best answer on suitability questions.
This exam isn’t essay-based. Each question gives you four choices, and your job is to pick the best one.
On suitability questions, the correct answer often isn’t the recommendation you’d make in real life. For example:
A 30-year-old investor with a moderate risk tolerance seeks a growth-oriented investment for their retirement account. What should you recommend?
Using the rule of 100, an average 30-year-old would typically have about 70% of their portfolio in common stock and 30% in fixed-income securities. Their moderate risk tolerance and growth objective point toward a growth stock or a growth stock fund.
But what if these are the answer choices?
A) Money market fund
B) Revenue bond
C) Convertible bond
D) Short index call
None of the choices looks like a growth stock or growth fund. That’s why elimination is so useful on suitability questions: you remove clearly unsuitable choices until the best remaining option is obvious.
With that in mind, which answer fits best?
Answer = C) Convertible bond
Start by eliminating the short index call. Short options are generally used to generate income and can involve significant risk. A short call, in particular, has unlimited risk. Options are also short-term instruments, which doesn’t align well with a long-term retirement growth objective.
Next, eliminate the money market fund. Money market funds emphasize safety and liquidity and typically offer low returns. They’re most suitable for very conservative investors or short time horizons, and they don’t offer meaningful growth potential.
The revenue bond is a municipal bond, which is generally most attractive to investors in higher tax brackets. More importantly, municipal bonds are not suitable for retirement plans. They also aren’t designed for capital appreciation, so they don’t match a growth objective.
That leaves the convertible bond. It’s not a perfect match for “growth,” but it’s the best of the four choices. The bond component provides income and relative stability, and the conversion feature creates potential for appreciation if the issuer’s common stock rises. It’s also a longer-term security, which fits a retirement time horizon better than the other remaining options.
On many suitability questions, the “best recommendation” in real life won’t appear as an answer choice. The exam is designed to test whether you can evaluate the facts and choose the best option available.
Some exam questions include extra information. For example, an options question might list six numbers even though you only need two. In those cases, the skill is filtering out what doesn’t matter.
Suitability questions work differently. In suitability scenarios, details are rarely random. Treat each fact as a breadcrumb pointing toward (or away from) certain recommendations.
John Washington is a 52-year-old investor with a $2 million portfolio invested in an S&P 500 index fund, growth funds, and various individual common stocks. He is a vice president at a large tech firm, making roughly $650,000 annually. As he nears retirement, John seeks guidance on diversifying his portfolio. He’s comfortable with his current allocation but is about to receive a $200,000 bonus and seeks your opinion on investing it. What should you recommend?
A) Balanced fund
B) Investment grade bond fund
C) Russell 2000 ETF
D) Municipal bond fund
You’ll see suitability questions written in paragraph form like this. The length can feel distracting, so it helps to capture the key facts (your exam notepad is useful here). For example:
Now match the answer choices to these facts. Which option best fits?
Answer = D) Municipal bond fund
Use elimination first. The Russell 2000 ETF tracks a small-cap stock index. Adding more stock to a portfolio that’s already 100% stock doesn’t improve diversification, so C is the easiest choice to eliminate.
Next, notice the investor’s goal: diversification as retirement approaches. With the existing portfolio entirely in equities, adding fixed income is the most direct way to diversify and reduce overall volatility.
A balanced fund holds both stocks and bonds. But this investor doesn’t need additional stock exposure, so it’s not the cleanest way to use the bonus for diversification.
That leaves two bond funds. Both add fixed income and reduce risk, which fits a near-retirement investor who is currently all-equity.
The deciding detail is the investor’s income. At roughly $650,000 per year, the investor is in the highest federal tax bracket (37%), regardless of filing status. A municipal bond fund is likely to provide a higher after-tax return than an investment grade bond fund made up primarily of taxable corporate bonds.
Notice how each detail mattered:
The North American Securities Administrators Association (NASAA) regulates the securities industry at the state level and is responsible for the exam content. It helps to approach suitability questions the way a regulator would.
NASAA’s primary goal is investor protection, especially protection from fraud and unsuitable recommendations. The industry has a long history of misconduct - from Bernie Madoff to Jordan Belfort to Elizabeth Holmes. Investor confidence matters because without it, markets can’t function effectively.
When you work through a suitability question, put on a “regulator hat.” Regulators focus heavily on the risk a recommendation exposes a client to.
Here’s how that looks in a practice question:
A 70-year-old investor living on a modest company pension and social security inherits $20,000 from a relative. Their current portfolio consists of growth funds and technology funds, which they want to keep in place. Although they are older, the investor prefers an aggressive portfolio. They wish to seek out an income-producing investment to supplement their retirement income. What should you recommend?
A) Investment grade bond fund
B) Growth and income fund
C) Index fund
D) High-yield income fund
Which answer fits best?
Answer = A) Investment grade bond fund
Eliminate the index fund. It’s reasonable to assume this refers to a stock index fund. The investor’s stated goal is income, and stock index funds typically aren’t chosen primarily for income.
Next, eliminate the growth and income fund. It’s still an equity fund (even if part of the portfolio focuses on dividend-paying stocks). Since two answer choices are bond funds - more directly aligned with “income-producing” - this equity fund is less suitable.
Now compare the two bond funds. The investor says they prefer an aggressive portfolio, which might make a high yield income fund tempting.
But the other facts matter:
From a regulator’s perspective, adding more credit risk through high-yield bonds isn’t the cautious choice. An investment grade bond fund still provides income, but with lower default risk than high-yield bonds, making it the better answer.
This is a classic “err on the side of caution” situation. When two choices could work, the less risky option is often the best exam answer.