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Building Customer Investment Profiles: Strategies & Importance

Instructor James Blackburn

James has over 25 years of experience in higher education. He has an MBA from Auburn University and MA in Humanities from Cal State Dominguez Hills. He is currently a Doctoral candidate at the University of North Georgia. James's research focus is on how storytelling can modify beliefs and behaviors.
This lesson will explore the steps in building a customer investment profile. You'll learn about the regulatory standards that guide the practitioner. The lesson will also identify the obligations each financial professional must satisfy.

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New Client

Two of Acme Financial's new clients, John and Jackie, sold some rental property last year. After paying off the remainder of the debt for the property, they had a large amount of money left over. For almost a year, that money was deposited in their savings account at the local bank. The interest rate on the savings account averaged about 1.5%. Which meant, for the $100,000 deposited into the savings account from the sale of the property, the net return on the deposit was only $1,510. So, John and Jackie sought advice on investment strategies.

Before Acme's advisor could offer any advice, the advisor first had to learn more about the couple. After all, it would be irresponsible to recommend an investment strategy without knowing even basic information about John and Jackie. The advisor needed to understand their current financial situation, their future plans and their risk profile at a minimum. More so, as a finance professional, he was required by FINRA rule 2111 to gather certain information about a client before offering advice.

FINRA's Suitability Rule

FINRA Rule 2111 Suitability states ''A member or an association must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer based on the customer's investment profile.'' The information an advisor needs to collect to complete the customer's investment profile includes the clients':

  • Age
  • Current financial situation
  • Investment goals
  • Investment experience
  • Time horizon of the investment
  • Liquidity needs
  • Risk tolerance
  • Other information needed to make an informed recommendation

To start, the advisor met with John and Jackie to learn more about their goals. The couple had a modest income from three other rental properties. Only one of the rental properties was debt free. The other two properties had fifteen and twenty years of payments remaining on their mortgages. Since the rental business is highly volatile, they needed to maintain a cash reserve for protection against a weak demand for the properties. Over the last ten years, the free income on the rental property sold last year averaged $8,000 per year. So, the $1,500 earned last year was not acceptable. The couple had a small retirement account with no other investments outside the rental property. They needed at least an 8% return and they knew the current strategy wasn't working.

The advisor provided John and Jackie a questionnaire that collected the basic information required by FINRA.

Investment strategy recommendations range from safe to risky to optimize the return. Each strategy is dependent upon the investors capability and willingness to lose the investment. The capability and willingness measurement is folded into a risk profile. The CFA Institute Research Foundation recommends an investor risk profile be completed to assist with a recommendation on an investment strategy. Creating this profile is a five-step process:

  1. Clear goals are defined
  2. Risk profile questionnaire is completed
  3. Risk profile questionnaire is scored
  4. Asset allocation is determined
  5. Investment strategy is implemented

John and Jackie's profile identified two areas of concern for any investment strategy. Since, the couple was close to retirement and needed to quick access to the funds, careful attention would have to paid to risk and liquidity. Risk is the willingness to lose the investment in return for higher returns. Liquidity is the ease to convert the investment into cash quickly. The investment strategy would need to protect the couple from loss of the investment and provide easy to access to cash in case of weak rental market.

Now, before making a final recommendation, the advisor needed to evaluate the investment strategy against three guidelines. FINRA provides these guidelines to help professionals with the reasonableness requirement. The three guideline questions are:

  • Is the investment strategy reasonable?
  • Is the investment strategy suitable for the client?
  • Is the investment strategy suitable quantitatively?

FINRA Rule 2111 in intended to provide investors with certain assurances by requiring finance professionals make reasonable investment recommendations. The rule accomplishes this goal by requiring finance professionals gather key information about the investor through the creation of a customer investment profile. One of the most important evaluations is the risk profile. The risk profile helps the finance professional make a recommendation that will balance the expected annual return and the financial ability of the investor to lose money.

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