Posted By: Dr. David Hetherington, CFA
Updated: July 26, 2018

Now that you’ve passed Level II, it’s time to start preparing for CFA® Level III. Join David Hetherington, CFA as he discusses what makes Level III more challenging than Levels I and II, and strategies to pass the final CFA exam.

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Video Transcription

Well, hello, everybody. Welcome to Level III. I’m David Hetherington. I manage the Level III curriculum, and probably you’re going to see a good bit of me on the teaching side of things as well. It’s not easy to get here, it’s also not a layup that you’re going to pass. So what are we going to do to improve your odds? I assume you’re still here and still in the CFA program because you’ve realized it’s valuable. Employers consider it worthwhile, it can enhance your career. How are we going to finish this thing off this year and get the charter?

About the Level III CFA® Exam

So we’ll talk a little bit about the pass rates. I’m sure everybody knows what they are, shouldn’t be any surprises there. What do people say about the CFA program, particularly Level III? And it gets into what makes it different and how do you go about succeeding? How do you adjust your plan so you can pass the Level III exam and be…sort of finish up this stage in your career? Level I, it’s often called trivial pursuit for financial analysts, it’s factoids. Learn those factoids, you’re going to get enough points, you’re going to pass the exam, that’s probably what you did. Maybe you did 3,000 multiple-choice questions, excellent strategy at Level I. At that point, there’s not that much they can come up with that you haven’t focused on how do I answer that question. Level II, charterholders usually say they consider Level II the hardest of the three exams. Those processes you went through, they’re not simple, they’re deterministic. Now, that’s a key word, deterministic. They’re math-based, you go through these steps in this order. This is the answer…ABC…which is the right answer?

So what happens at Level III? Well, they change the format of the test. You have to write. That’s a key difference. You’ve got to write things, and you can’t just pick A, B, or C. And it ties directly into how they’re changing what they’re asking. It’s more along the lines of a case study. While there may be math involved, in many cases it can’t be reduced to an equation. But people trained a certain way, given these set of facts, they say this is where you should have ended up, and they will grade you based on whether or not you end up at that same point. That can be a little bit disconcerting, so you’ve got to get your mind in line with what they’re thinking about, and we can show you how to do that. It’s actually not that tough.

CFA® Level III Pass Rates

When should you have taken Level III? Oh, that’s easy, 1964, look at the pass rate. That would’ve been a great year to have passed the exam. Basically, you showed up, you signed your name, you got your charter. Boy, this is good, and there was a trick, it was by invitation only. And we can’t go back to 1964. You can see we have been in this era of about 50% pass rates for quite a while. By the way, 2017, 54%, right in line with what you should expect it’s going to be. But notice how many people are taking the test. It’s been going up substantially. Look at that first year,1964, boy, it would have been great to be one of those 302 candidates, but we can’t go back to that. That’s kind of important because think about it, they’re doing written answers, and they’ve got to evaluate over 25,000 answers. This has nothing to do with college essay. This isn’t about ask the professor, “Hey prof, what are you going to ask me? How do you like me to write? What do you want?” It’s not going to work that way. There’s a standardized approach. If you know it you’re okay; if you don’t, you’re at a severe disadvantage.

The Peter Principle

Now, how many people have ever heard of the Peter Principle? This is Peter Drucker. He’s a famous management consultant, really part of the origins of the management consulting business. And he came up with a number of insights, one of which is called the Peter Principle. In simple terms, in organizations, people rise to their level of incompetence. He phrased that very carefully. He didn’t say people are incompetent. As you go through life, you get promoted for your successes, but as you get promoted, you get to something new where the same techniques you’ve used are not enough for the new challenges. And it’s human nature. We just, at some point there’s only so much change we’re willing to accept, so you keep succeeding, you keep getting to a new challenge, but then you get to a challenge where what you’ve done, which was great, but it doesn’t work now. The challenge is different. You need to change what you do. And Level III seems to be very…well, Level II was very significant in that regard. It was hard to transition from those simple 90-second standalone questions to the much more challenging approaches of Level II. A lot of people didn’t make it. You all did so you’re very, very successful.

But the Peter Principle says that doesn’t mean at the next challenge you’ll automatically succeed, and Level III we’ve seen also weeds out an awful lot of people. And it’s a change, it’s different, you keep all the skills you had, but you’ve got to add some different skills, and I think that’s where this Schweser can be quite a bit of help. So charterholders…this is the good news. If you ask charterholders, they almost universally say Level II was the hardest test, and they will often say Level III is the easiest test. But if you talk to candidates who are studying for Level III, you get a completely different perspective, you hear much more frustration. You literally run into people who are angry, they’re upset. “I don’t get it. What do they want me to do? I don’t understand. They won’t tell me what I think they need to tell me.” Well, there’s a secret there. You stop looking for what you think it should be and start focusing on what it actually is. Accept it for what it actually is, and you will begin to understand how to succeed here. And you do see that word “write.” You have to write out answers. That again, is not just a mechanical issue, it’s the nature of the questions that’s changing that’s linked to that change in format.

Constructed Response Questions

What does the Institute talk about? They do talk a great deal about the format of the exam, the constructed response, all the questions are different. Varying links, varying issues in each one, so while there are things to learn, the answer isn’t quite as mechanical as it was. Candidates respond to this in different ways, from, “Well, I don’t think this is a fair test,” to some of them get it. And the ones that get their charter they’re the ones that figure out what’s going on. Our goal is to help you understand that, to teach you how do you study for what’s coming next. Which by the way, fits perfectly with what employers are looking for, which is more in the nature of judgment. Hey, you really think when you’re trying to get hired for a really good investment job, because you memorized 25 equations, they’re going to hire you? Come on, it’s not worth paying you for that. Anybody can go look that stuff up. It’s the ability to apply and use judgment. So what else does the Institute say about the grading process, and again, particularly the constructed response, the morning session? Each grader gets the draft guideline answer, but more important they get a grading key, and the grading keys are never released, so you don’t get to see one, but it’s very specific.

These are the things that are in a successful answer, this is the point value that goes for each element of a successful answer, and we don’t even assume most people will get 100%. So the grader’s job is to dissect your answer and did you do the things expected? How many are there? So how many points can you get? But what if the grader’s just really impressed by your creative thinking? Won’t do you any good at all. That’s what they call the audit process. They go back and review the score, and if the grader didn’t follow the grading key, you don’t get those points. So you can’t treat this like college, and you’ve got to get on board with what they’re doing. But again, I’m not knocking it, because I was in the investment business as a practitioner, this is kind of second stage in life. You know, this is enjoyable to do. I like this stuff, but I’ve done it for real, I’ve been the hiring manager, I’ve been there interviewing for the job, on both sides of the table. The issue is did you actually learn anything from this curriculum? Do you understand the kinds of issues being presented? Because in the real world, it’s not just a cookbook. You’ve got to show judgment and initiative, and they found a pretty good way to test some of those skills at Level III, and that’s what’s going on. Less reading. Now, there’s still a lot of pages, but the number of pages is shorter.

And you also hear people say the reading is easier, but you hear other people say, "No, no, it’s not at all easy. It’s incredibly confusing because this reading says this and another reading said something different.” Well, they’ve fallen into the micro hole. Somebody used two different words. Two different people, two different words. Read the whole thing. They’re saying the same thing, it’s not contradictory at all. But if you focus on the micro, you think it’s contradictory, it’s your perspective, it’s very wordy. Everybody seems to agree on that. So you’ve got to extract what were the main issues? Stop focusing on every single detail, which is ironic because at Level I and II, that’s what you had to do. And now, it can get you in trouble at Level III if you don’t change your perspective. Having been a portfolio manager, of course you should think this way. Why wouldn’t you? I’m not going to hire you if you couldn’t figure this stuff out. But now, you’ve got to do that on the exam. So again, I think we can help get you there as it goes.

Why Constructed Response?

There’s lots of academic research to support why constructed response is used. Because you’ll fail. As simple as that. That’s why they do it, it’s kind of perverse. Various studies take a set of questions, come up with A, B, C as answers, give it to a group, let’s say 90% get it right. Take the same questions, take off the answers A, B, C, give them blank paper, hand it to a statistically identical group, and scores are much, much lower. You’re not prompted by seeing answers. There are no boundaries on what you’re doing, you just see this blank paper. There are boundaries, but you have to know what they are and apply them yourself. You can’t rely on the crutch of A, B, C to determine it.

I don’t know if you were expecting this much about theory of testing and different approaches, but this is what sinks people at Level III, and our goal this year is we don’t want to see you next year. We want this to be the last year you take a CFA exam because you succeed, you pass. You conquer this thing and you get your charter.

How to Answer Constructed Response Questions

So the morning exam is the constructed response part. It’s typically around 9 to 12 questions, every one has multiple parts. That is where most people have trouble. It’s three hours. The afternoon is the 6-question vignette style you learned at Level II. It’s kind of your friend, and there’s 10 of them. Don’t take it too lightly. Occasionally, we’ll run into candidates who do badly in the afternoon. It’s more technical, it’s more factual, it should be more comfortable, but you still have to do the work. There’s still material you’ll have to study and be prepared for, but we do spend a little more time focused on the morning, because we know that’s overwhelmingly where the difficulties lie for candidates at Level III.

So it’s not essay in the way a professor thinks of essay. It is absolutely not creative writing. It is constructed, keyword. What would someone trained a certain way have said and done. You did it, you do well. You didn’t do that? Oh, that’s very interesting. No credit. And they say that explicitly, you do not get credit for just displaying general knowledge. You must answer based on the CFA curriculum. So that’s kind of a tough message to get across. That’s what they mean by constructed response.

Recent exam and actually this is kind of, every year, the numbers change slightly, but the issues don’t. It’s 100% portfolio management in the morning. Now, in fact they will list on the first page how many questions, what’s the topic of each of those numbered questions. On this exam, it was 10 of them, and it will say portfolio management dash something. It may say portfolio management dash individuals, portfolio management dash institutions, portfolio management dash fixed income. One thing it’s not going to say: portfolio management dash financial reporting and analysis. That gets zero value on the Level III exam. So those things that were so important at Level I and II, they change the game, they’re looking for something different. You can see how the minutes for each question vary, and minutes or the number of points, you know it will add to 180 minutes, which are 180 points in the morning. And all the questions have different numbers of parts, and you can see each part varies in length. They used to…they gave you lined paper, and they gave you templates which were grids where you filled things in in certain areas. They’ve actually done away with that distinction. All of the questions they give you, they tell you what page to write the answer on. I kid you not—that itself is a frustration because you’re constantly going back and forth in the book from the question to where you have to write the answer for that question all in one book.

I had a candidate, I was actually responding to letters this morning, emails from candidates saying, “Man, I wish I’d actually practiced that. I didn’t realize how frustrating it was going to be to flip these pages all day long.” Or actually for only for three hours. You know, this stuff actually matters, so we’ll help you with that, but if you don’t write your answer where they tell you to write the answer, they won’t grade it. It’s as simple as that. You either do it or you fail that question. So you turn to the page, there’s a little box. Actually, it’s not little, they give you plenty of room, and you write your answer within that area. Are there any surprises? Of course there are. My assessment—everything on that exam we had covered it in our classes and gone through it and worked on it. Some of them were…there was a small percentage, I won’t argue with that, it’s a little bit surprising as an answer, not shocking. And actually what it came down to was the facts were so vague it wasn’t sure. Why would you focus on 1.7% of the exam? Focus on the rest of the exam, you have your charter. You can’t get hung up on an occasional bad question. Because there’s always a few of them, but there are very few.

So here is an example of what a question looks like. The first thing you see in bold is, this happens to be the very first question. They immediately tell you how many parts, and they tell you the total number of minutes, so that is 20 points of 180 points on the morning. And then you read what it asks for. And a question like this, this is what’s called the individual investment policy statement question objectives and constraints. There has been one of these for the last 20 years on every exam. And the six minutes refers only to part A, then there was B, C, and D follow up. So you kind of know what’s coming, but the case facts are always different. So there’s a process to answer this thing, but there’s no answer you can memorize that works. It’s do you know how to work through the process? It’s kind of like if somebody said, “Well, what’s the right…when they ask me to calculate the earnings per share…is it $1.50 or $1.60?” I got no freaking idea. Until you work through how to calculate earnings per share, you don’t know what the answer is going to be. The facts will differ, but the process is there. So while there’s not a precise formula per se to answer this, there’s absolutely a work process that we’ll be working through.

So essentially, what we’re saying to you is, you’re going to be taught a body of knowledge, you’re going to be given very specific case facts, a very specific question, and there’s a real small intersection where those three things come together. And it doesn’t lead to A, B, C, but it leads to you would have written something that is acceptable. We can’t say these are the only words you can use, it just don’t work that way anymore, but it’s easy to start wandering off on tangents and get it wrong. So getting used to that, it takes a little practice, it’s learnable. Again, the graders are only evaluating whether you did what was correct.

By the way, in this exact question, what is the process we’re going to study that goes beyond this determinant? What that means is, state in words, what do the Smiths expect? Calculate, calculate refers to a very specific work process. It varies based on the case facts, but there is a definite process you go through to answer that question. We’ll look at it. Basically, first you quantify…well, what am I starting with? What’s the money I have to work with since they want to know after-tax percentage required return? What is the amount I need the first year? You divide it, that’s a ratio, and let’s say we need to distribute 5% every year of the portfolio for them to live on. So if I earn 5%, will it be okay? Of course not. If I earn and distribute 5%, the nominal value of the portfolio will stay the same. If there’s anything other than zero inflation, that’s a losing proposition, so you have to deal with the future rate of inflation in determining what’s the required rate of return now.

How to Prepare for the CFA® Level III Exam

Did you know this is a taught process, and would you have known exactly what to do when you get this question on the exam? Again, think a little bit like Level II, there’s a process, but it’s a bit more open-ended than the things you did at Level II. You can do this, you made it, you can do it, it’s just a little adjustment. I think another issue is you’re so used to these precise calculations, you believe “oh, that’s what the business really is.” It’s not. What do you call an equity analyst who’s right 60% of the time? I think you call him a superstar. What do you call an equity analyst who says they’re right 100% of the time? I think you say they’re a liar because it’s not possible, it’s not the nature of our business. We deal with risky decisions, which means you cannot always be right. So you should be aiming for 90%. You know, everybody asks, “Well, what do I need to pass?” They won’t tell you. 70% is the popular number. I would say 70% is aiming for a marginal paper. It’ll probably be okay. Why in the world would you go to a test to probably be okay? But if you aim for 100%, you’re setting yourself up to fail. We’ll talk about aiming for 90%, and then you will not need to sit here next year again. You will have your charter.

I’m reiterating. A, B, C, guessing, easy. Blank paper, what do I do? Harder, and the clock is running. There’s a temptation when you don’t know, and it’s blank paper, just start writing a lot of stuff. You’re just wasting time. It will be completely evident from whatever you write you don’t know what you’re doing. So you’ve got to learn how to deal with that in the constructed response format. How do you learn to do things? You read, you watch, you listen, you think, and you practice. There is no substitute for that. We’re going to build in practice to every class at Level III. We’re going to give you ample opportunity to deal with a constructed response, as well as the item set, we’re going to coach you on the constructed response how to begin to understand, how to do it correctly, and we do that in essentially every single one of our classes. We do it in QBank questions on constructed response. We actually take you through old exam questions and show you how to have done an effective answer. If you’ve looked and seen the CFA sample answers, they’re very long-winded, and the Institute says they do not reflect what a candidate is expected to write. So you can’t use them as guidelines. We’ll show you what really is going on, and we’ll give you ample of it.

So you want to get through your basic preparation with at least a month to go before the exam. The classes will give you that, and then you turn more to practice exams. Now, what goes in before you get there? That’s the notes. The ondemand is a way to essentially use watching as a somewhat of a substitute for reading. You can do the CFA readings, but you certainly don’t want to do all of those, it’s a waste of time. To me it’s resources. I pick SchweserNotes. That’s the most popular way. You get to a reading and it’s not making sense, go try one of the others, see if that helps. Maybe that’ll work on that one, but you don’t do that for every single item. Come to classes. It’ll keep you on track. Focus on doing some questions every week on that material because this is only to get you ready for that final month’s push. Those, notice, are not exam questions, absolutely not. You can look at the exam questions and see they are not. So they’re only part of preliminary study, and working questions is a very effective way to reinforce what you’re learning, so don’t overlook that and don’t wait to work the questions. You want to be working some questions every single day, every single week. I was talking to Kurt…you’ll get to know as well, he’ll be responding to a lot of your emails. He was saying, "And you also need to practice writing every week.” You’ve got to nail this constructed response down so it’s no big deal by the time you go to the exam.

The final month we have given you more than enough questions to work on. Key thing, once is not enough, particularly in the constructed response. You want to have taken those exams, and you want to have time to come back and take it over again. Now, people say, “Well, what good is that? I’ve seen this question before.” Then I challenge you, why can’t you write a better answer this time? Because you’re not picking A, B, C, I want to see a more effective written response than the first time you did it. You’ve got to polish that up before it’s for real. These are things you never had to think about.

CFA® Level III Exam Topic Weights

Now, here are the typical weights that the Institute publishes. Notice how incredibly vague they are, and they’re quick to say, all of these are integrated into portfolio management. They actually say ethics is not, but when you go to the ethics, you find that emphasis is on portfolio management issues within ethics. That’s why we say this exam is actually 100% portfolio management. These are just subdivisions within portfolio management at Level III.

It’s a very different perspective from what you’re used to. And by the way, in the equity section, for example, would it surprise you to know there’s not going to be a single discounted cash flow reference in equity? By the way, they do mention it in economics when you’re looking at asset classes, but not when you’re doing individual equity. Different things than you’re used to thinking about. Just be prepared to have some fun, broaden your experience, increase your market value by passing the Level III exam, because you can certainly do it.

How Can Schweser Help You Pass?

Candidates talk about, "I spent the whole last month working and reworking exams, and focusing on main issues. I rewrote. I learned from mistakes.” I don’t care what your score is in practice, tell me what you were consistently getting wrong and what you’ve done to improve that. The failing candidates, it finally dawned on them, “Oh, this is not the same as Level II. I got to change what I’m doing.” They all say, “Yeah, there’s a few surprise questions,” but the smart ones say, "So what? What does that matter?” There’s always going to be a few surprises. Kurt and I…it’s well above 35 years experience helping people out. We’re going to tell you what you’re doing right, but we’re also going to have to point out to you when you’re doing the wrong things. Again, I was responding to emails this morning. A number of candidates were saying, “Man, you talked about tough love, thank you. I now figured it out. Yeah, I got to stop wandering off on tangents and get on with the business in front of me in this curriculum.” This is not, “What do you think?” This is, “What is the Institute trying to educate you on?” And we can get you there.

Now, we have lots of ways to help you. Our sales customer service can certainly help you out with how you’re going to approach things. I’m a big believer in classes either live or online because it’s structure, and Level III is more than just the facts. It’s how to understand, interpret, and apply them when you’re writing answers. That’s different than before. But I leave that to you. Kurt wanted me to remind you to go ahead and sign up so that it’s in place when it’s time to go to work. Don’t keep procrastinating. Go ahead and sign up and be ready to get to work. Plenty of material. In some ways, there’s too much material, so we’ll talk about breaking it down. What are the key issues? Read, class, where you hear and see, practice. That’s it.

Here’s different ways you can do it, but plenty of material and plenty of practice is included in that. Review courses, I’m a believer in it, that’s what I did when I took the curriculum. Your decision. I think it makes sense. You’re pulling together everything. Even more important in III, where everything is integrated together. And you will discover that when you say, "Oh, they talked about something in Study Session 4, and then it comes back in 8, and then it comes back in 10, and it’s all the same topic over and over again. Slightly differing perspectives. Review courses are a great way to figure that out. So get started, get busy, and get ready.

Now, hints, how do you do a constructed response? There’s a way to do it. Before you read all the stuff, what actually is the question? So as an example, suppose this was the first question. You shouldn’t read that, you don’t even know what the topic is. You shouldn’t read that, you shouldn’t read that. At the bottom of all that is the actual question. So the first thing you do is you read the question and get a basic understanding of the topic being tested. Now, it happens to be another one of those after-tax required nominal rates of return, because there’s been one of these for the last 20 years on every exam. Why wouldn’t we keep showing you how to do it? Knowing that’s the topic and, of course, by the time you get to this, you’ll know the process to answer it. Then you’ve got to go back through to all the facts. What are the case facts? You mark it, you look for the things that matter, you think about what you were taught, and then you start writing the answer down.

But you already know the structure, so blank paper really isn’t blank paper, because in your mind, you know what you’re supposed to do with that blank paper, and you will be evaluated whether you understood that and whether you executed that. And we actually take that same question and continue on in the constructed response videos, so we’ve got two more to sort of follow this. We’re really going to dig more into what makes Level III a challenge and, hey, what am I supposed to say? I’m supposed to say an opportunity. What is it? It’s a roadblock before you get your charter.

So we’re going to get you through that roadblock. You’ll learn what to look for, you’ll learn how to organize it, and then you’ll know how to answer this question. “What do I need to know?” That’s the taught process, it does take awhile to do it. You don’t know it all from Level I and II. Learning to read case facts, extract what matters, read these questions, and learn to understand what they expect you to do with them…and there’s an area, a sweet spot, “Oh, that was the answer to the question.” And we’ll be practicing that. You make your own good luck. You do it by preparing the right way. We don’t want you to have to continue this for multiple years. We want you to finish it up this year. So let’s make this the last year that you need to take a CFA exam. I’ll see you in class.
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