Investment Products on the Series 65 Exam
Section II (Investment Vehicle Characteristics) covers the features, risks, and uses of various investment products. This is one of the most heavily tested areas of the exam.
- 32 questions (~25% of the exam)
- Focus on characteristics and suitability, not sales
- Know the differences between similar products
As an investment adviser representative, you will help clients select appropriate investment vehicles based on their goals, risk tolerance, and time horizon. The Series 65 tests your understanding of how different products work, their tax implications, and when each is suitable.
This section covers pooled investments (mutual funds, ETFs, UITs), insurance products (annuities), alternative investments (REITs, limited partnerships), and important calculations like NAV. The exam focuses on comparing products and understanding their unique characteristics.
Pooled Investment Vehicles
Pooled investment vehicles allow investors to combine their money with other investors to access professionally managed, diversified portfolios. The three main types tested on the Series 65 are:
Mutual Funds
- Open-end investment companies
- Priced once daily at NAV
- Can be actively or passively managed
- Shares redeemed directly from the fund
Exchange-Traded Funds (ETFs)
- Trade on exchanges like stocks - Prices fluctuate throughout the day - Most are passively managed (index funds) - Generally more tax-efficient
Unit Investment Trusts (UITs)
- Fixed, unmanaged portfolio
- Set termination date (1-20 years)
- No active trading of securities
- Lower management fees
Test your ability to distinguish mutual funds, ETFs, and UITs:
- Pooled Investment Types Questions (3 questions)
- Pooled Investment Characteristics Questions (3 questions)
Mutual Funds vs. ETFs vs. UITs: Comparison
Understanding the differences between these pooled vehicles is essential for the exam. The table below highlights key distinctions:
| Feature | Mutual Fund | ETF | UIT |
|---|---|---|---|
| Management | Active or passive | Mostly passive (index) | Unmanaged (fixed portfolio) |
| Trading | Once daily at NAV | Throughout the day on exchange | Secondary market or sponsor |
| Pricing | End-of-day NAV | Real-time market price | NAV (may include sales charge) |
| Minimum Investment | Often $1,000-$3,000 | Price of one share | Varies ($1,000+) |
| Expense Ratio (Avg) | 0.42% | 0.15% | Lower (no ongoing management) |
| Tax Efficiency | Less efficient | More efficient | Moderate |
| Duration | No expiration | No expiration | Fixed termination date |
| Fractional Shares | Yes | Some brokers only | No |
With three pooled investment vehicles and eight distinguishing features to master, memorization is critical for exam success. Our flashcard strategies guide explains how to use FSRS-powered spaced repetition to memorize product distinctions efficiently. Not just “ETFs trade throughout the day” but exactly which features differ between mutual funds, ETFs, and UITs, ensuring you can quickly identify the correct product when exam questions test these characteristics.
Why ETFs Are More Tax-Efficient
ETFs have a structural advantage called the in-kind creation/redemption mechanism. When investors want to sell, the ETF can transfer securities directly to market makers instead of selling them. This avoids triggering capital gains that would be distributed to remaining shareholders.
Mutual funds, in contrast, must sell securities to meet redemptions, potentially generating capital gains that all shareholders must pay taxes on, even those who did not sell their shares. Practice distinguishing these characteristics with our pooled investment characteristics questions.
The exam often tests the difference between “priced once daily” (mutual funds) and “trades throughout the day” (ETFs). Remember: all mutual fund investors on the same day get the same price; ETF investors may pay different prices depending on when they trade.
When UITs Make Sense
UITs are suitable for investors who want:
- Transparency: You know exactly what securities are in the portfolio
- Defined outcome: The trust terminates at a known date
- Lower costs: No ongoing management fees (just creation costs)
- Predictable income: Fixed portfolio generates consistent cash flows
Master Investment Product Differences
ETFs vs. Mutual funds, UITs vs. Closed-end funds, fixed vs. Variable annuities: CertFuel tracks your accuracy on each product type separately. Our Smart Study algorithm identifies exactly which characteristics and tax treatments you're confusing.
Access Free BetaUnderstanding pooled vehicles is foundational, but many candidates miss investment product questions due to common application errors. Our common mistakes guide identifies the top exam failure patterns for Section II questions, including confusing ETF tax efficiency with passive management, missing the distinction between indexed annuities and variable annuities (securities status), and failing to recognize when UITs are more suitable than mutual funds despite lower liquidity.
Annuities: Fixed, Variable, and Indexed
Annuities are insurance products that provide a stream of income, typically for retirement. Understanding the three main types and their regulatory classification is critical for the Series 65.
Types of Annuities Comparison
| Feature | Fixed Annuity | Variable Annuity | Indexed Annuity |
|---|---|---|---|
| Returns | Guaranteed fixed rate | Market-dependent | Linked to index with caps |
| Principal Protection | Yes | No | Yes |
| Risk Level | Lowest | Highest | Moderate |
| Growth Potential | Limited | Unlimited | Capped |
| Fees | Lowest | Highest | Moderate |
| Regulated As | Insurance product | Security | Insurance product |
| Complexity | Low | High | Moderate |
Variable annuities are the only annuity type classified as a security because the investor bears market risk. They must be registered with the SEC and sold with a prospectus. Fixed and indexed annuities are insurance products only.
Fixed Annuities
Fixed annuities guarantee a set interest rate for a specified period. The insurance company assumes all investment risk. Key features:
- Guaranteed minimum interest rate
- Principal is protected from market losses
- Predictable income stream in retirement
- Regulated by state insurance commissioners, not the SEC
Variable Annuities
Variable annuities invest your premiums in subaccounts that function like mutual funds. Your returns depend entirely on subaccount performance:
- Choose from various investment options (stock funds, bond funds, etc.)
- Higher growth potential but also potential for losses
- Higher fees (M&E charges, subaccount fees, administrative fees)
- Optional riders for death benefits or guaranteed income (additional cost)
- Require a prospectus and securities registration
For practice on annuity types and suitability, see our insurance products questions.
Indexed (Fixed-Indexed) Annuities
Indexed annuities credit interest based on the performance of a market index (S&P 500, Dow Jones, etc.) while protecting principal:
- Participation rate: Percentage of index gain credited (e.g., 80%)
- Cap rate: Maximum interest credited in any period (e.g., 8%)
- Floor: Minimum credit, typically 0% (protects against losses)
- You never lose principal, but gains are limited
If the S&P 500 gains 12%, your indexed annuity has an 80% participation rate and a 10% cap, you receive 9.6% (12% x 80%), but capped at 10%. If the index falls 15%, you receive 0% (the floor), not -15%.
Variable, fixed, and indexed annuities each have unique characteristics. Practice identifying them:
- Insurance Products Questions (3 questions)
Annuity Tax Treatment
All annuities share similar tax treatment:
- Tax-deferred growth: Earnings grow without annual taxation
- Ordinary income: Distributions taxed as ordinary income (not capital gains)
- 10% penalty: Withdrawals before age 59½ may incur a 10% early withdrawal penalty
- LIFO taxation: Earnings come out first (Last In, First Out)
- Surrender charges: Most annuities have early surrender penalties in first 5-10 years
REITs and Limited Partnerships
REITs and limited partnerships offer exposure to real estate and other alternative investments. Understanding their structure and tax treatment is important for the exam.
Real Estate Investment Trusts (REITs)
A REIT is a company that owns, operates, or finances income-producing real estate. To qualify as a REIT, a company must:
- Invest at least 75% of assets in real estate
- Derive at least 75% of gross income from real estate
- Distribute at least 90% of taxable income to shareholders
- Have at least 100 shareholders
- Be managed by a board of directors or trustees
For more practice, see our alternative investments questions.
Types of REITs
Equity REITs
Own and operate income-producing real estate. Revenue comes from rent. Most common type (~90% of REITs).
Mortgage REITs
Invest in mortgages and mortgage-backed securities. Revenue comes from interest income. More sensitive to interest rates.
Hybrid REITs
Combine both equity and mortgage strategies. Less common.
Traded vs. Non-Traded REITs
| Feature | Publicly Traded REIT | Non-Traded REIT |
|---|---|---|
| Liquidity | High (trades on exchange) | Low (limited redemption) |
| Transparency | SEC reporting required | Less frequent disclosure |
| Fees | Lower | Higher (sales charges, fees) |
| Volatility | Higher (market-driven) | Lower (valued less frequently) |
| Minimum Investment | Price of one share | Often $1,000-$5,000+ |
Non-traded REITs have significant liquidity risk. Investors may not be able to sell when needed, and redemption programs can be suspended. High upfront fees (10-15%) can significantly reduce returns. These are suitable only for investors who can tolerate illiquidity.
Practice REIT suitability scenarios with our alternative investments questions.
Limited Partnerships (LPs)
Limited partnerships are investment structures with two types of partners:
- General Partner (GP): Manages the partnership, makes investment decisions, has unlimited liability
- Limited Partners (LPs): Passive investors, liability limited to their investment, cannot participate in management
LP Characteristics for the Series 65:
- Pass-through taxation: Income and losses flow directly to partners (no entity-level tax)
- Illiquid: No secondary market; investors typically hold until partnership terminates
- Accredited investors: Often limited to accredited investors due to risks
- Common uses: Real estate, oil and gas, equipment leasing, private equity
- K-1 tax forms: Partners receive Schedule K-1 instead of Form 1099
Test your knowledge of alternative structures with alternative investments questions.
Limited partners have limited liability (can only lose their investment) but must remain passive. If a limited partner participates in management, they can lose limited liability protection and become personally liable for partnership debts.
NAV Calculation
Net Asset Value (NAV) represents the per-share value of a mutual fund or other pooled investment. Understanding NAV calculation is essential for the Series 65.
NAV = (Total Assets - Total Liabilities) / Shares Outstanding
Components of NAV
Total Assets include:
- Market value of all securities (stocks, bonds, etc.)
- Cash and cash equivalents
- Accrued dividends and interest
- Any other receivables
Total Liabilities include:
- Management fees payable
- Operating expenses
- Transfer agent and custodian fees
- Any other payables
NAV Calculation Example
Example Calculation
Given:
- Total portfolio market value: $100,000,000
- Cash: $5,000,000
- Accrued dividends: $500,000
- Total liabilities: $5,500,000
- Shares outstanding: 5,000,000
Calculation:
Total Assets = $100,000,000 + $5,000,000 + $500,000 = $105,500,000
NAV = ($105,500,000 - $5,500,000) / 5,000,000 = $20.00 per share
NAV questions appear frequently. Practice with:
- Pooled Investment Types Questions (3 questions)
- Pooled Investment Characteristics Questions (3 questions)
When NAV Is Calculated
- Open-end mutual funds: Once daily after market close (4:00 PM ET)
- Closed-end funds: Periodically (weekly or monthly)
- ETFs: Calculated daily, but trade at market price (may differ from NAV)
Open-end mutual funds always trade at NAV. ETFs and closed-end funds trade at market prices that can be above (premium bond) or below (discount bond) NAV. ETFs typically trade very close to NAV due to the arbitrage mechanism.
The NAV calculation formula and the distinction between NAV, market price, and premium/discount pricing appear regularly on the Series 65. Our flashcard strategies guide provides techniques for memorizing the NAV formula components (total assets include securities, cash, and accrued dividends; liabilities include management fees and expenses) using FSRS algorithms, ensuring you can perform these calculations accurately under exam pressure, or practice with our pooled investment types questions.
Public Offering Price (POP)
For front-end load mutual funds, investors pay the Public Offering Price, which includes the sales charge:
For example, if NAV is $20.00 and the sales charge is 5%:
POP = $20.00 / (1 - 0.05) = $20.00 / 0.95 = $21.05
Series 65 Exam Tips: Investment Products
Here are the most commonly tested concepts and strategies for this section:
High-Priority Topics
- Mutual fund vs. ETF trading: Once daily at NAV vs. Throughout the day at market price
- Variable annuity classification: The only annuity type that is a security (investor bears market risk)
- NAV calculation: Know the formula and what goes into assets vs. Liabilities
- REIT distribution requirement: Must distribute at least 90% of taxable income
- UIT characteristics: Fixed portfolio, set termination date, unmanaged
Common Exam Traps
- Indexed annuities: They are insurance products, NOT securities (no market risk to principal)
- ETF tax efficiency: Due to in-kind redemptions, not because they track indexes
- Limited partner liability: Limited only if they remain passive; participation in management removes protection
- Non-traded REITs: “Non-traded” means illiquid, not unregistered; they are still SEC-registered
- NAV vs. POP: NAV is the fund value; POP includes sales charges
Create comparison flashcards for similar products: Mutual Funds vs. ETFs, Fixed vs. Variable Annuities, Traded vs. Non-Traded REITs. The exam frequently tests your ability to distinguish between similar options.
Investment products make up 25% of your exam (33 questions). Practice each category:
Fixed Income:
- Fixed Income Types Questions (3 questions)
- Fixed Income Valuation Questions (3 questions)
Equity:
- Equity Types Questions (2 questions)
- Equity Characteristics Questions (3 questions)
Pooled Investments:
- Pooled Investment Types Questions (3 questions)
- Pooled Investment Characteristics Questions (3 questions)
Derivatives & Alternatives:
- Derivative Types Questions (2 questions)
- Alternative Investments Questions (2 questions)
Insurance Products:
- Insurance Products Questions (2 questions)
Investment products represent 25% of your Series 65 exam (32 questions). A substantial portion requiring both memorization and scenario-based application. Our study schedule guide shows how to systematically prepare for Section II product characteristic questions while balancing the other three exam sections, ensuring you can distinguish between similar products and match them to client scenarios efficiently without over-investing time in just one section.
For more exam topic deep dives, explore our Exam Topics guides, see our complete formula reference for all the math you need to know, or start practicing with our investment vehicle questions.