Suitability basics

Suitability refers to the risks and benefits of an investment and is used to determine if an investment is appropriate for an investor. The Series 7 is essentially a suitability exam, with 73% of the exam covering some aspect of suitability.

When we cover various investments throughout this material, it’s important to understand the “BRTI” of these products:

• B - Benefits
• R - Risks
• TI - Typical Investor

Once you master these three concepts for each investment product, you can consistently make suitable recommendations on the exam and in the real world.

Let’s dive into the BRTI of common stock!

Generally speaking, investing in common stock is a young person’s game. Stocks come with considerable risks that may take years to recover from. For example, the Great Recession between 2007-2009 was catastrophic as many stocks lost upwards of 50% of their value. At times, companies with decades of success like Bear Stearns were going bankrupt.

Stocks have considerable market risk, which occurs if a market or economic circumstance causes general stock values to plummet. Other types of investments, like bonds, didn’t do well in the Great Recession, either. However, the bond market experienced fewer losses than the stock market.

The younger the investor, the more suitable stock is as an investment. It took the market several years to recover from the losses experienced in the Great Recession. Many older investors don’t have time to recover and may be required to sell their investments to free up needed cash.

Stocks may have considerable risk, but with risk comes return potential. You’ve probably heard the saying “more risk comes with more return.” Investments in risky securities are made because they come with a high potential to make money. Investors that lost significant amounts of money in the Great Recession between 2007-2009 recovered their losses, on average, by 2012. From there, the stock market grew to all-time highs in 2020. Bottom line, stocks may suffer significant losses when they’re down, but they provide a significant potential for return.

Stock investments are also a great hedge against inflation. Inflation occurs when general prices across the economy rise, rendering the purchasing power of the US Dollar downward. Have your grandparents or an older relative ever talked about how cheap certain things were when they were young? That’s inflation.

The stock market generally outpaces inflation over the long term. As prices of goods and services go up, stock prices tend to rise at a faster rate. For example, prices of goods at the grocery store may go up over the next 10 years, but stock values will likely outpace that growth. Therefore, if you want to have protection from rising prices, the stock market may be a good place to keep your money.