An investment plan must consider both investment objectives and investment constraints. Major constraints include liquidity, time horizon, tax concerns, legal and regulatory concerns and unique circumstances.
Liquidity refers to the need for cash in excess of any savings or new contributions available at a specific point in the future.Â Liquidity needs may be planned (child’s college funding in 10 years) or unplanned (a medical emergency) but both require ready ability to convert investments into cash. Some assets, such as real estate, may take considerable time to sell. Others, such as certificates of deposit, may impose early withdrawal penalties.
Time horizon typically refers to the time at which an investment objective must be met. Some objectives such as saving for a house may have a short time horizon, while retirement or endowment planning can have long horizons. Investors must often plan for several time horizons at once. The time horizon influences the ability to accept risk and could modify asset allocation strategy. Investors with little tolerance for temporary return fluctuations may need a different plan than would be suggested by time horizon alone, and multiple time horizons can further constrain allocation decisions.
Tax concerns include differences between the tax rates for different types of investment return (interest versus capital gains or dividends), estate taxes, differences between current income and retirement income tax rates, and the potential for tax legislation to change.
Legal and regulatory factors may include limits on the allocation to specific assets, the ability to access certain funds and even prohibitions on certain investments.
Unique circumstances may include social concerns and specific family needs.