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CFA Level I · CFA Level I Exam

Basics of Portfolio Planning and Construction for CFA Level I

Portfolio planning is the process of turning a client's needs into an investable plan. You write an Investment Policy Statement, set risk and return objectives, list constraints, choose a strategic asset allocation, then build the portfolio using a chosen approach, which may include ESG. Exam questions test whether each piece fits the client.

What this chapter covers

This chapter covers how a portfolio manager moves from a client's situation to a working portfolio. It starts with why holding many assets can lower risk, then moves to the Investment Policy Statement (IPS), the written document that records objectives and constraints. From there you learn how to set return and risk objectives, how constraints limit what is possible, and how a strategic asset allocation sets long-run weights across asset classes.

The last topic looks at how portfolios are built in practice. You compare approaches such as top-down and bottom-up, active and passive, and the ways ESG factors can be applied. The chapter is mostly conceptual. It has few calculations, but many questions ask you to judge which option suits a given client.

The chapter connects to much of the rest of the curriculum. Diversification builds on the risk and return ideas from Quantitative Methods. Asset allocation draws on Equities, Fixed Income and Alternative Investments, because you need to know what each asset class offers. Ethics also links in, since suitability and client duties sit behind every IPS decision.

Portfolio Construction carries a topic weight of 8-12% in the 2027 curriculum, and there is no minimum passing score per topic, so every mark counts toward the overall result. This chapter is also easier to score than most because the questions are mostly judgement based, not computational. If you learn the IPS structure and the logic behind each constraint, you can eliminate two wrong options quickly and save time for harder calculation questions elsewhere. It also gives you a framework that helps with Ethics and Portfolio Management items.

Basics of Portfolio Planning and Construction: topics in the order to study them

  1. 1Portfolio Approach and DiversificationIt sets the core idea that a portfolio is judged as a whole, which every later topic depends on.
  2. 2Investment Policy Statement (IPS)It gives you the structure that holds objectives and constraints, so the next two topics have a place to sit.
  3. 3Risk and Return ObjectivesThese are the first IPS sections to master, and you must separate willingness from ability to take risk.
  4. 4Investment ConstraintsConstraints complete the IPS and explain why two clients with similar goals can need different portfolios.
  5. 5Strategic Asset AllocationIt turns the finished IPS into long-run asset class weights, so you need the IPS first.
  6. 6Portfolio Construction Approaches and ESGIt comes last because it covers how to implement the allocation and needs all earlier ideas.

How to prepare Basics of Portfolio Planning and Construction

Aim for understanding first, then speed. Most questions are short client scenarios with three options, so practise reading a case and linking each fact to an IPS element.

  1. Read the diversification material and explain in your own words why combining assets with less than perfect correlation lowers portfolio risk.
  2. Memorise the IPS components in order, then write a short IPS for an imaginary client without looking at your notes.
  3. For risk objectives, practise sorting each client fact into ability to take risk or willingness to take risk. Remember that when the two conflict, the lower one usually guides the decision.
  4. Make a one-page table of constraints: liquidity, time horizon, tax, legal and regulatory, and unique circumstances. Add one example of each.
  5. Learn how the strategic asset allocation differs from tactical adjustments, and practise matching asset classes to client needs.
  6. Compare construction approaches in pairs, such as active versus passive and top-down versus bottom-up, and note ESG approaches with a one-line example each.
  7. Finish with timed sets of three-option questions at about 90 seconds each, and review every wrong answer by naming the IPS element it tested.

Common mistakes in Basics of Portfolio Planning and Construction

  • Treating objectives and constraints as the same thing

    Fix: Ask whether the fact states a goal or a limit. Goals are objectives; limits such as liquidity needs, tax and legal rules are constraints.

  • Choosing risk tolerance from willingness alone

    Fix: Check ability too. If ability is low, such as a short horizon or tight spending needs, the overall tolerance should be lower.

  • Assuming diversification removes all risk

    Fix: Remember that it reduces risk mainly when correlations are below 1, and that systematic risk stays.

  • Confusing strategic and tactical asset allocation

    Fix: Strategic is the long-run policy mix from the IPS. Tactical is a temporary tilt based on short-term views.

  • Memorising ESG terms without applying them

    Fix: Learn one concrete example for each approach and match it to the wording in the question stem.

  • Skipping practice because the chapter has few calculations

    Fix: Practise scenario questions under time. The traps are in reading client details carefully, not in arithmetic.

Last-day revision: Basics of Portfolio Planning and Construction

  • A portfolio is judged by its total risk and return, not asset by asset.
  • Diversification works because asset returns are not perfectly correlated.
  • The IPS is a written plan that records objectives and constraints and guides decisions.
  • Return and risk objectives are the goals; constraints are the limits.
  • Ability to take risk is about financial capacity; willingness is about attitude.
  • When ability and willingness differ, the more conservative one usually governs.
  • Constraints are liquidity, time horizon, tax, legal and regulatory, and unique circumstances.
  • A longer time horizon generally allows more illiquid and higher-risk assets.
  • Strategic asset allocation sets long-run target weights based on the IPS.
  • Tactical changes are short-term deviations from the strategic weights.
  • Top-down starts with macro views; bottom-up starts with security selection.
  • ESG can be applied by exclusion, integration, thematic investing or engagement.

Basics of Portfolio Planning and Construction practice questions

Basics of Portfolio Planning and Construction in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Basics of Portfolio Planning and Construction: frequently asked questions

How much of the CFA Level I exam is Portfolio Construction?

The 2027 curriculum gives Portfolio Construction a topic weight of 8-12%. There is no minimum passing score per topic, so strength here can offset weaker areas.

Does this chapter need a calculator?

Very little. The questions are mostly conceptual and scenario based. You should still be comfortable with basic portfolio risk and return ideas from Quantitative Methods.

What is the most important thing to learn in the IPS topic?

Learn the components and what each one records. Then practise reading a client case and assigning each fact to the correct component.

How should I answer client-suitability questions in three-option format?

Match every client fact to an objective or constraint, then remove options that break one of them. Usually one option fits the client's ability to take risk, horizon and liquidity needs better than the other two.