Investment Objectives and Constraints

Investment Objectives and Constraints

Investment Constraints

When creating a policy statement, it is important to consider an investor’s constraints. There are five types of constraints that need to be considered when creating a policy statement. They are as follows:

1. Liquidity Constraints – Liquidity constraints identify an investor’s need for liquidity, or cash. For example, within the next year, an investor needs $50,000 for the purchase of a new home. The $50,000 would be considered a liquidity constraint because it needs to be set aside (be liquid) for the investor.
2. Time Horizon – A time horizon constraint develops a timeline of an investor’s various financial needs. The time horizon also affects an investor’s ability to accept risk. If an investor has a long time horizon, the investor may have a greater ability to accept risk because he would have a longer time period to recoup any losses. This is unlike an investor with a shorter time horizon whose ability to accept risk may be lower because he would not have the ability to recoup any losses.
3. Tax Concerns – After-tax returns are the returns investors are focused on when creating an investment portfolio. If an investor is currently in a high tax bracket as a result of his income, it may be important to focus on investments that would not make the investor’s situation worse, like investing more heavily in tax-deferred investments.

1. Legal and Regulatory – Legal and regulatory factors can act as an investment constraint and must be considered. An example of this would occur in a trust. A trust could require that no more than 10% of the trust be distributed each year. Legal and regulatoryconstraints such as this one often can’t be changed and must not be overlooked.
2. Unique Circumstances – Any special needs or constraints not recognized in any of the constraints listed above would fall in this category. An example of a unique circumstance would be the constraint an investor might place on investing in any company that is not socially responsible, such as a tobacco company.

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