Identifying suitable investments is part art and part science. You need to understand product characteristics, investor profiles, investment objectives, and risk tolerance. The suitability-based chapters you’ve already covered focus on the “science.” Here, we’ll focus on the “art”: how to reason 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 available.
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 best recommendation in the real world isn’t always listed. That’s why elimination is such a reliable strategy.
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 also point toward a growth stock or growth stock fund.
But what if the answers are:
A) Money market fund
B) Revenue bond
C) Convertible bond
D) Short index call
None of these is a growth stock or growth fund. In a situation like this, you’ll usually get to the correct answer by eliminating choices that clearly don’t fit the investor’s objective, time horizon, or risk tolerance.
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 goal.
Next, eliminate the money market fund. Money market funds emphasize safety and liquidity and typically offer low returns. They’re most appropriate for very conservative investors or short time horizons, and they don’t offer meaningful growth potential.
Now consider the revenue bond. Revenue bonds are municipal bonds, which are generally most attractive to investors in higher tax brackets. However, municipal bonds are not suitable for retirement plans. They’re also unlikely to provide the kind of capital appreciation implied by a “growth-oriented” objective.
That leaves the convertible bond. It’s not a perfect match for a pure growth objective, but it’s the best of the four choices. The bond component provides income and relative stability, while the conversion feature creates potential for growth if the issuer’s common stock rises. It’s also a longer-term investment, which fits a retirement time horizon better than the other remaining choices.
On many suitability questions, you’re not choosing the ideal recommendation - you’re choosing the best recommendation among the choices provided. Test writers often design questions this way to see whether you can reason through suitability instead of relying on simple associations (for example, “young investor = growth stock”).
Some exam questions include extra information. For example, an options question might include six numbers even though you only need two. In those questions, you’re being tested on your ability to filter out what doesn’t matter.
Suitability questions work differently. In suitability scenarios, details are rarely random. Each fact is usually a clue that pushes you 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 isn’t the challenge - the challenge is tracking the facts. Your exam notepad can help. For example, you might jot down the key points:
Then compare each answer choice to these facts and choose the one that fits best.
Answer = D) Municipal bond fund
Use elimination.
Start with the Russell 2000 ETF. The Russell 2000 is a small-cap stock index. Buying more stock doesn’t address the stated goal (diversification away from an all-stock portfolio), so this choice can be eliminated.
Next, consider the balanced fund. Balanced funds typically hold a mix of stocks and bonds (often close to 50/50). This investor already has a large stock allocation and is comfortable keeping it. The question is specifically about investing the bonus to diversify, so adding a fund that still includes a substantial stock component is less direct than choosing a bond fund.
That leaves two bond funds: an investment grade bond fund and a municipal bond fund. Either would add fixed income and reduce overall portfolio risk, which fits a near-retirement investor who is currently 100% in equities.
The deciding detail is the investor’s income. At roughly $650,000 per year, the investor is in the highest 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 that primarily holds taxable corporate bonds.
Notice how every detail mattered:
As discussed earlier, the Financial Industry Regulatory Authority (FINRA) regulates the financial industry and writes the exam questions. The more you think from FINRA’s perspective, the easier it is to predict what the test considers “best.”
One of FINRA’s primary goals is protecting investors from fraud and deceptive practices. The industry has a long history of misconduct, from Bernie Madoff to Jordan Belfort. Investor confidence matters because without it, the industry can’t function.
When you answer suitability questions, put on a “regulator hat.” Regulators focus heavily on the risk a recommendation exposes a client to.
Here’s a practice question that shows how this works:
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
Answer = A) Investment grade bond fund
Eliminate the index fund. It’s reasonable to assume this refers to a stock index fund. The investor is looking for income, and stock index funds typically aren’t chosen primarily for income.
Next, eliminate the growth and income fund. This is still an equity fund (with a mix of growth and dividend-paying stocks). The remaining two choices are bond funds, which are more directly aligned with an income objective.
Now compare the two bond funds. The investor says they prefer an aggressive portfolio, which might make a high yield income fund seem tempting. But the rest of the facts point toward caution:
From a regulator’s perspective, adding lower-quality bonds on top of an already aggressive allocation increases risk in a situation where stable income is the goal. An investment grade bond fund is the better fit because it targets income with less credit risk.
This is a classic “err on the side of caution” scenario. When two answers could work, the exam often rewards the choice that reduces risk while still meeting the investor’s stated objective.