R02 Applying asset allocation to client profiles: free practice questions

1. Question 1 of 5

   Why are broad labels such as 'medium risk' considered too simplistic for risk profiling?

   Option A: They only apply to pension investmentsOption B: They're banned by the FCA for use with clientsOption C: Clients can mean different things by the same labelOption D: They're far too precise to be useful in practice

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   The answer is C: Clients can mean different things by the same label

   Labels such as low, medium and high risk are too broad. Advisers can use questionnaires, psychometric tools, AI tools and scales, but the discussion with the client is usually the most important part.

   Why the other options are wrong

   A

   They're used for all investments.

   B

   They aren't banned, just imprecise.

   D

   The problem is that they're too broad.

2. Question 2 of 5

   How can an adviser diversify a portfolio beyond asset allocation?

   Option A: By using only one investment style across the portfolioOption B: By increasing the cash weighting to 100%Option C: By holding all of the funds from a single managerOption D: By using fund managers with different styles and methods

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   The answer is D: By using fund managers with different styles and methods

   Each style has periods of above- and below-average returns. Value strategies often do well in stable conditions and momentum in rapid growth, so blending styles adds diversification.

   Why the other options are wrong

   A

   Styles go through good and bad periods.

   B

   That isn't diversification.

   C

   That concentrates manager risk.

3. Question 3 of 5

   How does tactical asset allocation differ from strategic asset allocation?

   Option A: It's used only for income portfoliosOption B: It never changes the asset mixOption C: It makes short-term moves within set bandsOption D: It sets the long-term mix from the risk profile

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   The answer is C: It makes short-term moves within set bands

   Strategic allocation, set from the risk profile, is the long-term mix. Tactical allocation moves within bands, say 10% to 20%, towards the top or bottom of each range on a short-term basis.

   Why the other options are wrong

   A

   Large tactical changes are mainly used for growth portfolios.

   B

   Tactical allocation does change the mix.

   D

   That's strategic allocation.

4. Question 4 of 5

   What does research suggest about how often portfolios should be rebalanced?

   Option A: Daily rebalancing gives the best results over timeOption B: Only once every ten years, at mostOption C: More often than six-monthly adds little benefitOption D: Rebalancing should never be done

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   The answer is C: More often than six-monthly adds little benefit

   Rebalancing more than every six months yields little extra benefit. It assumes reversion to the mean, for which the evidence is strong, although timescales are unpredictable.

   Why the other options are wrong

   A

   Very frequent rebalancing adds little.

   B

   That would let allocations drift a long way.

   D

   Rebalancing keeps the allocation in line with the risk profile.

5. Question 5 of 5

   What is sequencing risk?

   Option A: The risk of a fund manager leavingOption B: The risk of withdrawing too much during or just after a downturnOption C: The risk that one asset class always follows another in the cycleOption D: The risk of buying funds in the wrong order on a platform

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   The answer is B: The risk of withdrawing too much during or just after a downturn

   Sequencing risk is withdrawing capital during or after a downturn, which drags on growth. Once withdrawals start, the order of returns matters, and it rises with equity content.

   Why the other options are wrong

   A

   That's key person risk.

   C

   It's about the order of returns during withdrawals.

   D

   The order of purchases isn't the issue.

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