16.3 Step 1: Determine Investment Objectives And Constraints

Learn about Step 1 in the portfolio management process: determining investment objectives and constraints. Understanding these factors is critical for effective asset allocation tailored to a client's specific needs.


Determining investment objectives and constraints is the crucial first step in establishing a personalized asset allocation for a client’s portfolio. Knowing a client’s goals help translate desires into feasible investment objectives while considering their unique constraints.

Key Components of Step 1

Investment Objectives

The primary investment objectives typically include:

  1. Safety of Principal (or preservation of capital)
  2. Income
  3. Growth of Capital

Secondary considerations might include liquidity (ease of converting assets into cash) and tax minimization.

Investment Constraints

Constraints need to be identified and considered to ensure the portfolio aligns with the client’s reality and goals. Common constraints include:

  1. Time Horizon
  2. Liquidity Requirements
  3. Tax Considerations
  4. Legal and Regulatory Constraints
  5. Unique Circumstances

Detailed Analysis

Return and Risk Objectives

To craft a sound investment strategy, it is essential to answer:

  1. What rate of return does the client need?
  2. What risk is the client willing and able to take?

The return objective looks at the average yearly return needed to meet client goals in alignment with their risk tolerance. Questions during the client interview phase should reveal whether the preference is for maximizing return or minimizing losses. The risk objective measures the client’s readiness to tolerate investment risk to achieve their return objectives.

Inflation Protection: Ensuring future purchasing power is a significant concern, particularly for retired clients needing steady cash flow.

Risk Categories in Asset Classes

Different asset classes embody distinct risk levels:

Cash and Cash Equivalents

  • Government Issues (less than a year): Lowest risk, highest quality
  • Corporate Issues (less than a year): Higher risk, lower quality

Fixed-Income Securities

  • Short-term (1–5 years): Low risk, low volatility
  • Medium-term (5–10 years): Medium risk, medium volatility
  • Long-term (10+ years): High risk, high volatility


  • Conservative: Low risk, high capitalization, predictable earnings
  • Growth: Medium risk, potential for above-average earnings growth
  • Venture: High risk, low capitalization, limited earnings record
  • Speculative: Maximum risk, high price volatility

Investment Components Descriptions

  1. Safety of Principal: Ensuring the initial investment stays intact, accepting lower income return and growth.
  2. Income: Regular cash flows from debt and equity securities, crucial for clients relying on steady income.
  3. Growth: Profit made by selling securities more than their purchase cost with favorable tax considerations.

Application Examples

  • Safety: Young couple saving for a house purchase.
  • Income: Single parent relying on investments for additional income.
  • Growth: Young executive aiming to build capital for early retirement.

Major Security Types Evaluation (Table 16.2)

Security Type Safety Income Growth
Short-term Bonds Best Very Steady Very Limited
Long-term Bonds Next Best Very Steady Variable
Preferred Shares Good Steady Variable
Common Shares Often the Least Variable Often the Most

Typically, clients might have secondary objectives such as liquidity and tax minimization, both of which significantly impact portfolio strategies.

Frequently Asked Questions (FAQs)

  1. Why is specifying investment objectives so important? Specifying objectives allows for tailor-made investment strategies to meet unique client goals while considering their constraints and risk tolerance.

  2. Can investment objectives change over time? Yes, as a client’s financial situation and life circumstances evolve, their investment objectives might require adjustments.

  3. What is the relationship between risk and return? Generally, higher potential returns come with higher levels of risk, necessitating a careful balance based on client profiles.

Key Takeaways

  • Investment objectives and constraints must be clearly understood to craft a reliable investment portfolio.
  • Risk and return objectives are created based on in-depth client interviews and assessments.
  • Awareness of various constraints, including time horizon, liquidity requirements, tax, legal, and unique individual circumstances, is essential for portfolio success.


  • Asset Allocation: Distribution of investments across various asset classes.
  • Risk Tolerance: Maximum amount of variation in investment returns that a client is willing to withstand.
  • Smooth Yield Curve: Representation of bond yields at different maturities, which becomes important for portfolio strategy during market fluctuations.

Equation for Expected Portfolio Return

The expected return of a portfolio can be estimated as:

$$E(R_P) = \sum_{i=1}^{n} w_i R_i$$
  • \( E(R_P) \): Expected return of the portfolio.
  • \( w_i \): Weight of asset \( i \).
  • \( R_i \): Return of asset \( i \).
  • \( \sum_{i=1}^{n} \): Summation from 1 to \( n \) (number of assets).

Note: The weights in the portfolio must sum to 1.

CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## Which of the following is NOT a primary investment objective? - [ ] Safety of principal - [ ] Income - [x] Liquidity - [ ] Growth of capital > **Explanation:** Primary investment objectives include safety of principal, income, and growth of capital. Liquidity is typically considered a secondary objective. ## What question helps determine a client's return objective? - [ ] How much do you want to invest? - [ ] What kind of investments do you prefer? - [x] What rate of return do you need to attain your stated goals? - [ ] How soon do you need your money back? > **Explanation:** Determining the return objective involves asking what rate of return the client needs to attain their stated goals. ## A client’s risk objective must address: - [ ] The time horizon of their investments - [ ] The types of assets they prefer - [ ] The amount of cash they hold - [x] The risk the client is willing and able to take on to achieve the return objective > **Explanation:** The risk objective is a measure of the risk a client is willing and able to undertake to meet their return objectives. ## Which statement is FALSE about safety of principal? - [ ] It prioritizes the initial capital remaining intact. - [ ] High safety often means lower returns. - [ ] Government bonds held to maturity offer high safety. - [x] It ensures high growth potential. > **Explanation:** Safety of principal emphasizes keeping the initial investment intact, often sacrificing high growth potential for lower risk. ## What is typically affected significantly by a client's marginal tax rate? - [x] The proportion of income received as interest vs. dividends - [ ] The need for portfolio liquidity - [ ] The selection of government bonds - [ ] The client's time horizon > **Explanation:** A client's marginal tax rate can greatly affect the proportion of income received as interest, which is taxed differently from dividends. ## What can necessitate the re-evaluation of a client's portfolio? - [ ] High market volatility - [x] A major change in the client’s circumstances - [ ] Frequent market fluctuations - [ ] Short-term interest rate changes > **Explanation:** Major changes in a client's circumstances, such as retirement, health issues, or career changes, necessitate re-evaluation of the portfolio. ## How is liquidity defined in the context of investments? - [ ] The ability to earn high returns quickly - [ ] The reduction of investment risk - [x] The ease and speed with which an investment can be converted to cash - [ ] The stability of investment prices > **Explanation:** Liquidity refers to the ease and speed with which assets can be converted into cash without significantly affecting their price. ## What should be considered under legal and regulatory requirements as constraints? - [ ] Client’s risk tolerance - [ ] Investment goals - [x] Compliance with applicable laws and regulations - [ ] Investment returns > **Explanation:** Legal and regulatory constraints require compliance with laws, regulations, and any relevant industry guidelines. ## Which factor is NOT typically considered a unique circumstance in investment planning? - [ ] Ethically and socially responsible investing - [ ] Personal convictions about certain industries - [ ] Significant health issues - [x] Time horizon for investment goals > **Explanation:** Unique circumstances typically refer to ethical preferences, personal convictions, or health conditions, rather than the time horizon for investment goals. ## How is risk differentiated in equities according to Table 16.1? - [ ] By fixed interest rates - [x] By factors such as capitalization, earnings performance, and price volatility - [ ] By sector and industry averages - [ ] By short-term versus long-term investment cycles > **Explanation:** Equities’ risk is differentiated based on factors like capitalization, earnings performance, liquidity, and price volatility.

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Sunday, July 21, 2024