Module 3: Investment Planning
What Module 3 tests
Module 3 is investment planning: risk and return, asset classes, diversification, portfolio construction, securities analysis, mutual funds and ETFs, derivatives, behavioral biases, and performance evaluation. Questions often require calculating a portfolio return or judging suitability.
Core rules
- Return has two parts: income and capital gain. Risk includes volatility, credit, liquidity, inflation, currency, and horizon risk.
- Diversification reduces unsystematic risk, not market risk. Asset allocation usually explains most return variability.
- Use expected return as a weighted average: portfolio return = sum of weight times asset return. Compare net returns after fees and taxes.
- Match risk to capacity and willingness, and to goal horizon. Rebalance with rules, not emotion.
Worked example
A client allocates 60% to equities with expected return 8% and 40% to bonds with expected return 3%. Expected portfolio return = 0.60 x 8% + 0.40 x 3% = 4.8% + 1.2% = 6.0%. If inflation is 2.5% and fees are 0.5%, the approximate real net return is 6.0% - 0.5% - 2.5% = 3.0%. The planner then asks whether a 6.0% nominal assumption is reasonable and whether the client can tolerate a 20% equity drawdown.
Traps
Using past performance as a forecast; ignoring fees, taxes, and inflation; treating low volatility as no risk; chasing winners; using leverage or derivatives without understanding; comparing returns with different time periods or risk levels.