Lesson 4 of 7 · 14 min
Constraints: liquidity, horizon, tax, legal and unique circumstances
Five types of constraint limit which assets suit a client: cash needs, the time horizon, taxes, laws and regulations, and anything else unique about the client, including their values and their other exposures.
In short
- Liquidity: expected withdrawals should be covered by liquid, low-risk assets maturing around the time of need. Unpredictable claims (e.g. property and casualty insurance) mean higher liquidity needs than predictable ones (life insurance).
- Time horizon: the period until withdrawals start or circumstances change. Short horizons rule out illiquid or risky assets; long horizons can use them.
- Tax: income is often taxed more heavily and earlier than capital gains, so taxable investors may favour gains and tax-exempt bonds; tax-exempt investors (e.g. pension funds) are indifferent to the form of return.
- Legal and regulatory: limits on equities, foreign assets or self-investment for pension funds; insider trading restrictions on a client who holds material nonpublic information must be noted.
- Unique circumstances: faith, ethics and ESG preferences (e.g. Shari'a, socially responsible investing) and exposures outside the portfolio such as human capital in one industry or employer stock.
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