Series 65 Section III: client recommendations and strategies — what’s tested and the traps
Section III of the Series 65 (Uniform Investment Adviser Law Examination) is “Client Investment Recommendations and Strategies”: 30% of the exam, 39 of the 130 scored questions, on turning a client’s profile into a recommendation and measuring how it did.
- Section
- III
- Outline weight
- 30%
- Scored items
- 39 of 130
- Drill here
- 12 questions
What Section III covers
NASAA’s content outline (effective June 2023) splits Section III into eleven components, A to K. Tied with Section IV for the biggest share of the exam, it is the section where arithmetic and judgment meet: some items ask what fits this client, others ask you to compute or name a number, and many need both.
30%
of the exam
tied with Section IV for the largest share
39
scored questions
out of 130; the 10 unscored items can come from any section
11
outline components
A–K, paraphrased in the table below
12
drill items on this page
original practice questions, one section only
| Component | What the questions turn on |
|---|---|
| A. Client types | Individuals, business entities, trusts and estates, foundations and charities |
| B. Client profile | Goals, cash flow, balance sheet, taxes, risk tolerance, time horizon, ESG or religious limits |
| C. Capital market theory | CAPM, modern portfolio theory, efficient markets |
| D. Portfolio management | Strategic vs tactical, active vs passive, styles, dollar-cost averaging, options, leverage |
| E. Tax | Capital gains, dividends, basis, AMT, RMDs, entities, estate and gift tax |
| F. Retirement plans | IRAs, 401(k), 403(b), 457, SEP, SIMPLE, defined benefit, nonqualified |
| G. ERISA | Fiduciary duty, §404(c), QDIA, prohibited transactions |
| H. Special accounts | 529, Coverdell, UTMA/UGMA, HSA |
| I. Ownership and estates | JTWROS, TIC, TBE, TOD/POD, trusts and wills |
| J. Trading | Order types, short sales, margin, principal vs agency |
| K. Performance | Time- vs dollar-weighted, risk-adjusted, real and after-tax return |
Condensed from the June 2023 outline; read the NASAA PDF for the full wording.
If your time is short, put it into E, F and K first. All three are rule-and-number components: a memorized rule or formula settles the answer, so an hour there converts to points faster than an hour on theory.
Client profile and suitability
Every recommendation question starts with the profile, even when the stem buries it in the second sentence. Before you read the four choices, pull out three things: the time horizon, the tax bracket and the stated limits (liquidity needs, ESG or religious screens, a concentrated position). Most wrong answers are good investments for a different client.
- Risk capacity vs risk tolerance
- Capacity is financial: how big a loss the balance sheet and income can absorb. Tolerance is psychological: how much volatility the client can sit through without selling. When they conflict, the lower one governs.
- Time horizon
- When the money is needed, not the client’s age. A 70-year-old funding a grandchild’s trust can have a 20-year horizon.
- Liquidity need
- Cash the client must reach within about a year. It belongs in cash equivalents before anything else is allocated.
Portfolio management and asset allocation
Theory questions here (components C and D) are short and definitional; the trading questions (J) reward a quick sketch of where the market price sits.
| First term | Second term | |
|---|---|---|
| Allocation | Strategic: a long-term target mix, restored by rebalancing | Tactical: a short-term tilt away from that target to exploit a view |
| Management | Active: tries to beat a benchmark; higher costs and turnover | Passive: tracks an index; low cost, accepts market return |
| Efficient markets | Weak form: past prices are priced in, so technical analysis fails | Semi-strong: all public data is priced in, so fundamental analysis fails too |
| Risk priced by CAPM | Systematic (market) risk, measured by beta | Unsystematic risk earns no premium, because diversification removes it |
| Stop orders | Buy stop: placed above the market; protects a short position | Sell stop: placed below the market; protects a long position |
| Firm’s role | Principal: trades from its own inventory, charges a markup | Agent: arranges the trade, charges a commission — never both on one trade |
Two more easy points. With dollar-cost averaging, a fixed sum buys more shares when prices are low, so the average cost ends up below the average price. A limit order guarantees the price, never the execution.
Taxes, retirement plans and special accounts
Components E through I are the densest block of Section III, and the one older prep material gets wrong, because SECURE 2.0 and the 2025 tax law moved several numbers. Learn the rule first and the figure second.
Basis and capital gains
- Inherited property gets a step-up to its value at the date of death; gifted property keeps the donor’s carryover basis (for a loss, the lower of basis or fair market value).
- A wash sale — buying back substantially the same security within 30 days before or after a sale at a loss — disallows the loss and adds it to the new basis.
- Net capital losses offset up to $3,000 of ordinary income a year; the rest carries forward with no time limit.
- Incentive stock options are not taxed at exercise for regular tax, but the spread is an AMT item. Nonqualified options create ordinary income at exercise.
Retirement plans and RMDs
| Account | Rule to know | 2026 number |
|---|---|---|
| 401(k), 403(b), 457(b) | Employee deferral; extra catch-up at 50+ (higher at ages 60–63) | $24,500 + $8,000 catch-up |
| Traditional / Roth IRA | Same combined limit across both types | $7,500 + $1,100 catch-up |
| Governmental 457(b) | No 10% early-withdrawal penalty after separation from service | — |
| Coverdell ESA | Contributions before the beneficiary turns 18; funds used by 30 | $2,000 per beneficiary |
| 529 plan | No federal deduction; 5-year gift-tax averaging; a lifetime 529-to-Roth rollover is allowed under conditions | $35,000 rollover cap |
| UTMA/UGMA | Irrevocable gift to one minor; one custodian; no margin; kiddie tax applies | — |
| HSA | Needs a high-deductible health plan; non-medical withdrawals after 65 are taxed but not penalized | — |
Dollar limits are indexed and change every year; recheck them before you sit. For 2026 the annual gift exclusion is $19,000 per recipient.
The 10% penalty on withdrawals before 59½ has exceptions (substantially equal periodic payments under 72(t) is the classic one). Under ERISA §404(c), a plan that offers at least three diversified options and lets participants switch at least quarterly shifts responsibility for the participant’s own picks — but never for choosing and monitoring the menu. A capital-preservation fund qualifies as a default (QDIA) only for the first 120 days.
Ownership and estates
- JTWROS
- Equal shares; on a death the share passes to the surviving owner outside probate.
- Tenants in common (TIC)
- Shares may be unequal; a deceased owner’s share goes to their estate, so it goes through probate.
- Tenancy by the entirety (TBE)
- Spouses only, with creditor protection in the states that recognize it.
- TOD / POD
- A beneficiary designation that moves the account at death without probate.
- Per stirpes vs per capita
- Per stirpes passes a deceased beneficiary’s share down that branch of the family; per capita splits equally among the beneficiaries still living.
Performance measurement (with worked examples)
Component K is where the calculator comes out, but the harder half of each question is choosing the yardstick. Ask who is being graded, and against which kind of risk, before you touch a number.
Time-weighted return (TWR), annualized
[(1 + r₁)(1 + r₂)…(1 + rₙ)]^(1/n) − 1Ignores when money went in or out, so it grades the manager.
Dollar-weighted return (DWR)
the IRR that makes PV(deposits) = PV(withdrawals + ending value)Weights each period by the money in the account, so it reports the client’s own result.
Sharpe ratio
(Rp − Rf) ÷ σpExcess return per unit of total risk.
Treynor ratio
(Rp − Rf) ÷ βpExcess return per unit of systematic risk.
Jensen’s alpha
Rp − [Rf + βp(Rm − Rf)]Return above what CAPM predicts for that beta. Positive means value added.
- Start of year 1
- $20,000 deposited
- Year 1 return
- −10% → $18,000
- Start of year 2
- $20,000 more → $38,000
- Year 2 return
- +25% → $47,500
- TWR: (0.90 × 1.25)^½ − 1 = 1.125^½ − 1 ≈ +6.1% a year. The deposits never enter the formula.
- DWR: find r where 20,000 + 20,000 ÷ (1 + r) = 47,500 ÷ (1 + r)². Solving the quadratic gives 1 + r ≈ 1.120, so r ≈ +12.0% a year.
- The client did better than the manager because the second, equal-sized deposit landed just before the good year.
Evaluating the manager: TWR, +6.1%. What the client earned on their money: DWR, +12.0%. Reverse the timing and the gap reverses too.
- Risk-free rate
- 4%
- Market return
- 9%
- Fund A
- return 10%, σ 10%, β 1.2
- Fund B
- return 12%, σ 16%, β 0.8
- Sharpe: A = (10 − 4) ÷ 10 = 0.60; B = (12 − 4) ÷ 16 = 0.50. A wins on total risk.
- Treynor: A = 6 ÷ 1.2 = 5.0; B = 8 ÷ 0.8 = 10.0. B wins on systematic risk.
- Jensen’s alpha: A = 10 − (4 + 1.2 × 5) = 0; B = 12 − (4 + 0.8 × 5) = +4.
- B carries a lot of unsystematic risk: high σ for its low beta. That risk only disappears inside a diversified portfolio.
If the fund is the client’s whole portfolio, total risk matters: use Sharpe and choose A. If it is one sleeve of a well-diversified portfolio, use Treynor (or alpha) and choose B.
Common traps
These are the swaps Section III builds its distractors from. Each one looks like a fact question but is really a test of which rule applies.
Sharpe or beta?
A stem asks for the measure of excess return per unit of total risk. Beta measures sensitivity to the market only, and alpha is a return figure, not a ratio.
Sharpe uses standard deviation; Treynor uses beta.
Strategic or tactical?
An adviser holds a 60/40 target but moves to 70/30 for two quarters on an economic view, planning to return to 60/40.
Tactical: a temporary tilt from a strategic target.
Qualified or nonqualified plan?
An executive wants to defer more than the 401(k) limit through a plan offered only to a few top employees.
Nonqualified: it can discriminate, but the deferred money stays a company liability.
Inherited or gifted shares?
Shares bought at $10 are worth $50 when they change hands. The new owner’s basis depends on how they arrived.
Inherited: $50 step-up. Gifted at a gain: $10 carryover.
Practice: Section III questions
The pad below holds 12 original practice items, all from Section III. Answer one and the reasoning, with a note on every option, opens underneath. Skip to the second pass parks a question until the first pass is done, the habit worth using on test day. Nothing is kept after you close the page, and no score is predicted.
Section III drill · 12 questions
0 of 12 answered · 0 right
Question 1 of 12§ III · Strategies
What is the primary tax advantage of qualified dividends compared to ordinary dividends?
Pick an answer. The reasoning, and a note on every option, appears here.
Keys: 1–4 or A–D answer · N next · S skip
Twelve items is a spot check, not a measure. The free 60-question practice test carries 18 Section III items alongside the other three sections, and the study plan shows where Section III fits in the weeks before your test date. For the map of all four sections, go back to the Series 65 study guide.
FAQ
What is on Section III of the Series 65?
Section III, Client Investment Recommendations and Strategies, is 30% of the exam: 39 of the 130 scored questions. It covers client types and profiles, capital market theory, portfolio management, taxes, retirement plans and ERISA, special accounts, ownership and estates, trading, and performance measurement.
What is the difference between time-weighted and dollar-weighted return?
Time-weighted return strips out the timing of deposits and withdrawals, so it measures the manager. Dollar-weighted return is the internal rate of return on the client’s actual cash flows, so it measures what the client earned. They differ whenever money moves in or out before a strong or weak period.
How many Section III questions do I need to get right?
There is no per-section cut. The pass is 92 of the 130 scored questions across the whole exam, so strength in Section III can offset a weaker section.
Section III, one item at a time
The Series 65 practice app keeps every section’s questions in your pocket, with a note on each option.