Saturday, October 27, 2012

Equity Indexed Annuities: the industry perspective

Let's look at what appears to be a good, fair-and-balanced look at equity indexed annuities from the perspective of the industry:

FINRA Enforces MSRB rules on David Lerner Associates

If you think that what you study for your exam has "nothing to do with the real world," please check out this story:

Excessive mark-ups will lead to trouble . . . eventually. Ignoring suitability concerns . . . same deal.

Oh well. David Lerner--the guy--will apparently be in the market for some Pass the 7 materials eventually. And, fortuitously, we will have our Pass the 24 materials ready by the time he needs to re-qualify by passing that one as well. Series7SampleQuestions

Wednesday, October 24, 2012

Mutual Fund Portfolios

Let's take a somewhat detailed look at a mutual fund's balance sheet and income statement:
Series 7Help

Tuesday, October 23, 2012

What IS a Series 7?

Maybe you're wondering what a Series 7 is, what it's used for, and why you might or might not want to go there. Click on the video below if you're curious . . .

Wednesday, October 17, 2012

Series 7 Exam Sample Suitability Question

Here's a practice question similar to what you might see at the Series 7 Exam testing center:

Your customer has $60,000 that she would like to invest for her son's education. Her son is 9 and so far has shown little interest in academics. The customer wants tax-deferred growth but does not want her son to be able to use the money if he chooses not to go to college. Your customer should invest in or through a
A. UTMA account
B. Coverdell Education Savings Account
C. 529 Plan
D. Mutual Fund

Not sure? Click the video below to see a step-by-step explanation:


Series 7 Help?

Sample Suitability Question for Series 7, Annuities

Even though many Series 7 candidates will not get their Life & Health licenses, expect your exam to ask a few questions about insurance-based products. Not just variable annuities, but fixed/equity-indexed annuities, and not just variable life insurance, but also perhaps a little bit about whole life and term life insurance. To make sure you know the basics of annuities, let's do a sample suitability question:

Your customer is ready to retire next month. She wants to receive a monthly check for as long as she lives, but she is not impressed with the low rates of return on the fixed annuity illustration you walked her through last week. She has concerns about purchasing power and has a moderate risk tolerance; therefore, she would most likely be interested in which of the following?
A. deferred variable annuity
B. immediate variable annuity
C. deferred indexed annuity
D. immediate fixed annuity

EXPLANATION: as always, what can we eliminate? The phrase "ready to retire next month" eliminates choices A and C--deferral periods are perhaps 10 years long; this person wants  payments immediately. Now, while I would prefer the immediate FIXED product; this individual clearly wants the VARIABLE annuity so she can be partly invested in stocks. Right? The answer is B here, no doubt about it. Get Series 7 Practice Questions Here

Monday, October 15, 2012

Series 7 Sample Question - Suitability

Our Pass the 7 ExamCram Online Test Prep now has a quiz called "Suitability of Customer Recommendations." It is up to 35 questions, and I hope to double that number ASAP. For now, let's do a practice question that forces the test taker to show the test he or she knows the different types of mutual funds. Here goes:

Your customer is a 66-year-old recently retired school teacher living on a defined benefit pension. Her monthly check from the teacher's retirement system covers her expenses, but she also remembers the rampant inflation of the 1970's and is afraid her pension income won't keep up with rising prices. She also foresees some major home repairs in the future, none of which is critical for probably 5 - 7 years. Which of the following funds seems LEAST suitable given her needs?
A.equity income fund fund
C.balanced fund
D.large cap value fund 

Don't assume that "66-year-old retired teacher" is code for "pick something really conservative." No, this investor already has something really conservative--a defined benefit pension check coming every month for as long as she lives. Her income piece is pretty well covered, but she worries about inflation and needs to build up some capital to be used for home repairs 5-7 years out. That means she has to be in the stock market. It also means she can' afford to be super aggressive, not over a 5-7-year time horizon. An aggressive growth investor would need a 10-year-plus time horizon because when it's time to put a new roof on the house, it's just not acceptable for the investor to sell when her investment is temporarily down 40%. And that scenario is quite common in the world of aggressive growth stocks and mutual funds. On the other hand, this question doesn't present any aggressive investments, so at first it's hard to see how any of them would be less than suitable. But, if we hold fast to the idea that she needs to be in the stock market to protect her purchasing power, possibly receive a higher income stream down the line, and build up some capital for a 5-7-year goal, we see that only one of these choices does not provide access to the stock market. By definition, a bond fund is not about the stock market, right? An equity income fund is mostly about stocks and about finding issuers that pay ever-rising dividends. A balanced fund always has a large % in the stock market, and always in a well-diversified, conservative allocation. A large cap value fund is comprised of large companies that are currently trading on the cheap--meaning, high dividend yields a-plenty. So, again, the one that is not in the stock market is LEAST suitable--the bond fund, ANSWER B. Practice Questions Online

Wednesday, October 10, 2012

What does FINRA say about suitability?

For a deeper understanding of your new suitability requirements (after passing your exam, of course, and getting registered) please check out what FINRA has to say about the topic at

For example, aren't we all kind of curious to know the answer to this question?

Would a firm violate the suitability rule if it makes recommendations to customers
for whom it has not obtained all of the customer-specific information listed in FINRA
Rule 2111?

Studying for Series 7?

Tuesday, October 9, 2012

Risk Tolerance

So, an investor might have the primary objective of growth/capital appreciation. He may also have a time horizon of 20 years. However, if he doesn’t have the risk tolerance required of the stock market, we have to keep him out of stocks. Remember that risk tolerance has to do with not only the financial resources, but also the psychological ability to sustain wide fluctuations in market value, as well as the occasional loss of principal that makes investing so much fun in the first place. The terms “risk-averse,” “conservative,” and “low risk tolerance” all mean the same thing—these investors will not tolerate big market drops. They invest in safe, boring things like fixed annuities, US Treasuries, and investment-grade bonds. In order to invest in sector funds or emerging market funds the investor needs a high risk tolerance. Moderate risk tolerance would likely match up with balanced funds, equity income funds, and conservative bond funds.
Putting the three together (investment objectives, time horizon, risk tolerance), then, if we know the investor in the question seeks growth, we then have to know his time horizon and risk tolerance. If he’s a 32-year-old in an IRA account, his time horizon is long-term. Unless he has a low risk tolerance you would almost have to recommend growth funds. If the investor is 60 years old and living on a pension income, she might need to invest in common stock to protect her purchasing power. If so, her time horizon is long, but maybe her risk tolerance is lower than the 32-year-old's. So, we’d probably find a conservative stock fund—not a small cap growth or “international discovery” fund—maybe a growth & income or equity income fund. If another investor seeks income primarily, we need to know her time horizon and risk tolerance. We don’t buy bonds that mature beyond her anticipated holding period. If she has a 10-year time horizon, we need bonds that mature in 10 years or sooner. Her risk tolerance will tell us if we can maximize her income with high-yield bonds, or if we should instead be smart and buy investment-grade bond funds. If she needs tax-exempt income, clearly, we put some of her money into municipal bond funds. For capital preservation nothing beats US Treasury securities. GNMA securities are also very safe. Money market mutual funds are safe—though not guaranteed by the US Government or anyone else—but they pay low yields. Money market mutual funds are for people who not only want to preserve capital but also make frequent withdrawals from the account. See, even though your money is safer in a 30-year Treasury bond than in a money market mutual fund, the big difference is that the market price of your T-bond fluctuates (rates up, price down), while the money market mutual fund stays at  $1 per share.
Seriously. So if liquidity is a major concern, the money market mutual fund is actually better than T-bonds, T-notes, and even T-bills, all of which have to be sold at whatever price. With the money market mutual fund, you can write checks, and the fund company will redeem the right number of shares to cover it.
Total liquidity. And totally boring, just as many investors like it.Suitability Questions for Series 7

Time Horizon

. . . Once we've determined the investor's investment objectives, it's time to talk about her time horizon. In general the longer the time horizon the more volatility the investor can withstand. If you have a three-year time horizon, you need to stay almost completely out of the stock market and invest instead in high-quality bonds with short terms to maturity. If you’re in for the long haul, on the other hand, who cares what happens this year? It’s what happens over a 20- or 30-year period that matters. With dividends reinvested, the S&P 500 has historically gained about 10% annually on average, which means your money would double approximately every 7 years. Sure, the index can drop 30% one year and 20% the next, but we’re not keeping score every year—it’s where we go over the long haul that counts. A good way to see the real-world application of risk as it relates to time horizon would be to pull out the prospectus for a growth fund and see if you can spot any two- or three-year periods where the bar charts are pointing the wrong way—then compare those horrible short-term periods to the 10-year return, which is probably decent no matter which growth fund you’re looking at. That’s why the prospectus will remind folks that they “may lose money by investing in the fund” and that “the likelihood of loss is greater the shorter the holding period.”
Younger investors saving for retirement have a long time horizon, so they can withstand more ups and downs along the road. On the other hand, when you’re 69 years old, you probably need some income and maybe not so much volatility in your investing life. So the farther from retirement she is, the more likely she’ll be buying stock. The closer she gets to retirement, the less stock she needs and the more bonds/income investments she should be buying. In fact, you may have noticed that many mutual fund companies are taking all of the work out of retirement planning for investors, and offering target funds. Here, the investor picks a mutual fund with a target date close to her own retirement date. If she’s currently in her mid 40s, maybe she picks the Target 2030 Fund. If she’s in her mid 50s, maybe it’s the Target 2020 Fund. For the Target 2030, we’d see that the fund is invested more in the stock market and less in the bond market than the Target 2020 fund. In other words, the fund automatically changes the allocation from mostly stock to mostly bonds as we get closer and closer to the target date.Series 7 Exam Help

Big 3: Objectives, Time Horizon, and Risk Tolerance

When presented with a suitability question on the Series 7 Exam, try to think as you will once you get your license. First, what are the goals of the investor? What are her investment objectives? Investment objectives include: capital preservation, income, growth & income, growth, and speculation. If the individual is in his 30’s and is setting up a retirement account, he probably needs growth to build up his net worth before reaching retirement age. If he’s already in retirement, he probably needs income. He might need income almost exclusively, or, to protect his purchasing power, he might also need growth. And, as you might expect, this is where growth & income funds come in very handy. But, any blue chip stock that pays regular dividends would fit that bill, also. Or, even a bond that is convertible—that would be income plus potential growth. This test—you’ll see—likes to make you think way outside the box. Some firms separate growth from aggressive growthAggressive growth investments include international funds, sector funds (healthcare, telecommunications, financial services, etc.) and emerging market funds (China, India, Brazil, etc.). For speculation, there are options and futures, and most investors should limit their exposure to these derivatives to maybe 5-15% of their portfolio.Some folks are already rich, and they wisely just want to preserve their capital (capital preservation). We won’t tell them about buying US Treasury securities all on their own, without commissions. Instead, we’ll put them into a US Treasury mutual fund. Even though the fund is not guaranteed, the securities the fund owns are.Need Help Passing the 7?

Monday, October 8, 2012

What Does the Series 7 Mean by Suitability?

When the Series 7 Exam asks 70 questions on "suitability," what does that actually mean? Well, as you would assume, it covers recommendations to customers that you will make through short-story questions. But, the suitability questions also expect you to know about economic factors, industry news sources, and product features/benefits/risks/costs. This is from the Series 7 Exam outline:

T4.1 Obtains information regarding current domestic and global market events, economic/financial news, industry sectors, and the status of markets and securities from various appropriate sources to assess how this information may impact the markets, issuers and customers’ accounts
T4.2 Communicates relevant market, investment and research data to customers
T4.3 Makes suitable investment recommendations
T4.4 Provides appropriate disclosures concerning products, risks, services, costs and fees
T4.5 Provides customers with information on investment strategies and explains how the risks and rewards of a particular investment or strategy relate to the customer’s financial needs and investment objectives

Help with Series 7 Exam


Thursday, October 4, 2012

Suitability of Options on Series 7 Exam

Series 7 exam questions on options do not always involve calculations or numbers of any kind. To me, the most challenging and relevant options questions on the Series 7 exam are the ones that ask for a recommendation. If the customer has purchased the stock and now feels it may "move sideways," how can he generate additional income?
He can sell a covered call. Now, don't assume your question will use the word "sideways," as if that is some scientific term. It will let you know in some subtle, roundabout way that the stock is expected to go, like, nowhere, so why not collect call premiums rather than just sit around doing nothing?
If an investor expects the stock to sit perfectly still over the next few weeks or months, his maximum, gutsy play would be to write a straddle. I mean, if the stock really goes nowhere, both the writer of a call and the writer of a put would profit; therefore, why not be BOTH the writer of a call and the writer of a put with the same strike price? On the other hand, one only buys a straddle if he feels the stock will surely move big-time in either direction. Buyers of options need MOVEMENT, so if the question implies that the individual feels the stock might not move, that person is a SELLER of options. If you BUY an option, the stock always has to move, and by more than the premium you just paid to get in. This is true of buying single calls and puts, buying straddles, and establishing debit spreads--all are BUYERS, all need movement from the underlying instrument. If you think the market might sit still or work against the buyer, you sell calls and puts, sell straddles, or establish credit spreads. Suitability Questions in ExamCram Online

Wednesday, October 3, 2012

Suitability of Annuities on Series 7 Exam

If you're trying to make a recommendation concerning annuities in a Series 7 exam question, carefully read the facts to determine the following. First, does this investor want a safe, guaranteed rate of return backed by an insurance company's claims paying ability, or do they seek purchasing power protection/growth? If the former--they need a fixed or indexed annuity. If the latter, they're leaning toward a variable annuity--IF they can handle the risks of the stock and bond markets.
Now, when do they need the money to start coming out of the account? If they're at retirement age now, they need the money immediately--they want an immediate fixed, immediate indexed, or immediate variable annuity. If retirement is a long way off, and they won't have to touch this money for 10 years or more--they want a deferred fixed, deferred indexed, or deferred variable annuity.
Those are really the only big considerations. Do you want an insurance product or a securities product? Fixed and indexed annuities are insurance products. They buy a lot of sleep but don't provide much return. Variable annuities offer more upside and purchasing power protection, but the money is not really safe here. Then, when do you want to start taking withdrawals? Now--immediate annuity. Later--deferred annuity. Suitability Questions in ExamCram Online