Competency 18 Section 1

Question 1

1. With the safety-first approach, the focus of investing is to maximize wealth subject to one’s risk tolerance

Answer 1

False. The safety-first approach focuses on lifetime spending potential, not wealth maximization. (LO 18-1-1)

Question 2

2. The safety-first approach is persuaded by the historical result that 4% is a sustainable withdrawal rate over a 30-year time horizon for a portfolio of volatile assets.

Answer 2

False. The safety-first approach suggests that risky assets are inherently risky and just because something may have worked in the limited historical record does not mean it can be expected to continue working in the future. (LO 18-1-1)

Question 3

3. With the safety-first approach, inflation-adjusted single-premium immediate annuities provide a fundamental tool for building a lifetime income floor to ensure that basic needs will be met

Answer 3

True. (LO 18-1-1)

Question 4

4. With the safety-first approach, the client’s entire balance sheet of human, social, and financial capital is used to develop a retirement income strategy.

Answer 4

True. (LO 18-1-1)

Question 5

5. Hedging in the safety-first approach is a risk management tool which seeks assets whose fluctuating value will be aligned with the fluctuating value of future spending needs.

Answer 5

True. (LO 18-1-1)

Question 6

6. With the probability-based approach, stocks are considered to be less risky in the long-run because the probability of bad outcomes decreases with time

Answer 6

True. (LO 18-1-2)

Question 7

7. Annuities are a key part of the retirement income portfolio in the probability-based approach.

Answer 7

False. Annuities could have limited uses, but are generally too costly for any marginal increase in safety over a systematic withdrawal strategy. Also, the cost of annuitizing basic needs could lower the changes to achieve entire lifestyle spending goal. (LO 18-1-2)

Question 8

8. Key risk management tools for the probability-based approach include precautionary savings, portfolio diversification, hedging, and insurance.

Answer 8

False. The probability-based approach relies primarily on precautionary savings and portfolio diversification. (LO 18-1-2)

Question 9

9. With the probability-based approach, the U.S. historical record since 1926 included sufficient economic disasters that one can be relatively confident that 4% is a lower bound for a sustainable withdrawal rate from a portfolio of volatile assets over a 30-year horizon.

Answer 9

True. (LO 18-1-2)

Question 10

10.With the probability-based approach, retirees divide their spending goals between essential needs and discretionary expenses and emphasize the importance of making sure that essential needs will be met.

Answer 10

False. Spending goals are not prioritized as the view is that retirees have a particular lifestyle goal in mind and not meeting that overall goal indicates failure. (LO 18-1-2)

Question 11

37. Which of the following statements accurately describes the investment strategy for the “safety-first” retirement income approach? (LO 18-1-1)

A. Assets are matched to goals so the risk levels are comparable.

B. A total return approach is used.

C. A time-segmented total return approach is used.

D. A buy and hold indexing approach is used

Answer 11

37. The answer is A. The safety-first approach uses a liability-driven investment strategy.

Question 12

38. Which of the following is one of the primary risk management tools for the “probability based” retirement income approach? (LO 18-1-2)

A. Portfolio diversification

B. Hedging

C. Insurance

D. Variable annuities

Answer 12

38. The answer is A. Precautionary savings and portfolio diversification are the two primary techniques

Question 13

63. According to the “probability based” retirement income approach, which of the following statements is (are) correct? (LO 18-1-2)

I. A segmented investment approach is almost always used.

II. Goals are prioritized and the investment strategy is adjusted accordingly.

A. I only

B. II only

C. Both I and II

D. Neither I nor II

Answer 13

63. The answer is D. A total returns approach is typically used and goals are not often prioritized

Question 14

93. Under a “safety-first” retirement income approach, all of the following should be used to meet basic spending needs EXCEPT (LO 18-1-1)

A. Social Security

B. Bond ladders

C. Fixed annuities

D. Equities

Answer 14

93. The answer is D. Basic needs should be matched with the safest and least volatile assets.