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CFA Level I Exam · Basics of Portfolio Planning and Construction

Investment Constraints in the IPS Explained

Updated 7 October 2026 · Fact-checked

Investment constraints are the limits on what a portfolio can hold, set in the investment policy statement. The five are liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances. To solve a question, read the client facts, sort each into a constraint, then pick the asset allocation that respects every limit.

Understand Investment Constraints

An investment policy statement (IPS) has two halves. Objectives say what the client wants: return and risk. Constraints say what limits how the client can get there. A client may want high return, but constraints can rule out some assets.

The usual memory aid is RRTTLLU: Return, Risk, Time horizon, Tax concerns, Liquidity, Legal and regulatory factors, Unique circumstances. The first two letters are the objectives. The constraints are the last five letters, TTLLU.

Liquidity is the need for cash. It can be a planned outflow, such as a tuition payment, or an unexpected one, such as an emergency. Cash needs are met from cash and easily sold assets. Illiquid assets like private equity or real estate are harder to sell quickly, so large liquidity needs limit them.

Time horizon is how long the money is invested before it is needed. A long horizon lets the investor take more risk, since there is time to recover from losses. A short horizon calls for stable, liquid assets. Some clients have several horizons, called a multistage horizon, for example working years then retirement.

Time horizon and liquidity are different. Horizon is about when the money is needed in total. Liquidity is about cash needed along the way. A young investor with a 35-year horizon may still need a large cash reserve now, and a retiree with a long life expectancy may have little liquidity need if income is steady.

Tax concerns affect which assets and accounts suit the client. Returns are judged after tax, and tax treatment of interest, dividends and capital gains can differ. Legal and regulatory factors are external rules, such as trust law, prudent-investor rules, or limits on a pension fund or insurer. Unique circumstances cover everything else: ESG or religious restrictions, a concentrated holding in the employer's stock, health needs, or a client with special preferences.

Key formulas to remember

Constraint checklist (TTLLU, the last five letters of RRTTLLU)
Time horizon, Tax concerns, Liquidity, Legal and regulatory, Unique circumstances
Constraints limit choices. Return and risk are objectives, not constraints.
Horizon and risk ability
Longer horizon → higher ability to take risk; shorter horizon → lower ability
This is a general tendency, not a fixed rule. Willingness to take risk is a separate matter.
Liquidity and asset choice
Larger or nearer cash needs → hold more cash and liquid assets; fewer illiquid assets
Applies to both known and unexpected cash needs.
After-tax return
After-tax return = pre-tax return × (1 − tax rate)
Applies when the whole return is taxed at one rate. Different tax rates on income and gains need separate treatment.

How to solve Investment Constraints questions

Use this method for any constraint question, whether it asks you to name constraints or choose a suitable portfolio.

  1. 1Read the case and underline every fact about cash needs, dates, taxes, rules and personal wishes.
  2. 2Sort each fact under one of the five constraints. Ask: is this about cash (liquidity), timing (horizon), tax, law, or something personal (unique)?
  3. 3Separate objectives from constraints. Required return and risk tolerance are objectives, so ignore them for a constraint label.
  4. 4For horizon, decide if it is short, long or multistage, and note when each stage begins.
  5. 5For liquidity, note whether the need is planned or unexpected, and how large it is compared with the portfolio.
  6. 6Test each answer choice against every constraint. Remove any choice that breaks one.
  7. 7Choose the option that satisfies all constraints, then check it again against the stated facts.

Quickest way: Label, then eliminate

When to use it: Use this for three-option MCQs where you have about 90 seconds.

  1. Find the key phrase in the stem: a date, a cash need, a tax mention, a rule or a personal preference.
  2. Match it to one letter of TTLLU. Cash need now means liquidity. Years until needed means horizon.
  3. Cross out the option that mismatches the label, such as calling a regulation a unique circumstance.
  4. Between the last two, pick the one that fits the specific facts, not general ideas.
  5. Move on. There is no penalty for a wrong answer, so never leave it blank.

Common mistakes in Investment Constraints

  • Treating liquidity and time horizon as the same thing.

    Both involve timing, so they feel alike.

    Fix: Horizon is when the main money is needed. Liquidity is the cash needed along the way, and its size and timing.

  • Listing risk tolerance or required return as a constraint.

    The RRTTLLU memory aid puts them next to the constraints.

    Fix: Return and risk are objectives. Only time horizon, tax, liquidity, legal and regulatory, and unique circumstances are constraints.

  • Assuming a long horizon always means high risk is appropriate.

    Students memorise the general link and stop there.

    Fix: Horizon affects ability to take risk. Willingness and liquidity needs can still limit it. Check all facts.

  • Putting an external rule under unique circumstances.

    Unusual rules feel unique.

    Fix: If an outside body or law sets the rule, it is legal and regulatory. Unique circumstances are client-specific, such as ethical exclusions or a concentrated holding.

  • Ignoring taxes when comparing returns.

    Students compare pre-tax returns by habit.

    Fix: Compare after-tax returns when the case gives a tax rate or mentions taxable and tax-free accounts.

  • Forgetting multistage horizons.

    Students pick one number of years for the whole case.

    Fix: If the case describes phases such as working life then retirement, treat the horizon as multistage and consider each phase.

Worked examples

Example 1

A 40-year-old client plans to retire at 65 and expects to live until 90. She has an average tolerance for risk and no restrictions on holding equities. She wants the portfolio to fund her retirement. She also must pay a house deposit of €120,000 in 18 months from the portfolio. Which constraint does the deposit mainly illustrate, and how should it affect the portfolio?
A. Time horizon: allow only short-term assets for the whole portfolio
B. Liquidity: set aside enough in cash or liquid assets for the deposit
C. Unique circumstance: exclude all equity holdings

Show the solution
  1. The deposit is a known cash need on a specific date, 18 months away.
  2. A cash need along the way is a liquidity constraint, not a horizon constraint.
  3. The retirement goal is long-term, so the overall horizon is long. Only the deposit amount needs to be safe.
  4. Option A applies the short horizon to the whole portfolio, which is too broad.
  5. Option C mislabels the deposit as a unique circumstance and excludes all equities with no basis. She has average risk tolerance, no restriction on equities and a long horizon for the retirement part, so equity is still acceptable for that part.
  6. Option B matches: keep the deposit in cash or liquid, low-risk assets and invest the rest for the long term.

Answer: B. The deposit is a liquidity constraint, so reserve the €120,000 in cash or liquid assets and invest the rest for the long horizon.

Example 2

A foundation's board decides, for mission reasons, that the portfolio will avoid tobacco companies. No law or regulation requires this. Separately, national law requires the foundation to hold only investments meeting a prudent-investor standard. How should these two items be classified in the IPS?
A. Tobacco exclusion: unique circumstance; prudent-investor standard: legal and regulatory
B. Tobacco exclusion: legal and regulatory; prudent-investor standard: unique circumstance
C. Both as time horizon constraints

Show the solution
  1. The prudent-investor standard is set by law, so it is a legal and regulatory factor.
  2. The tobacco exclusion is a choice made by the foundation's board for its own mission. No outside rule imposes it.
  3. A client-specific ethical or mission preference is a unique circumstance.
  4. So the tobacco exclusion is unique and the prudent-investor standard is legal and regulatory.
  5. Neither item relates to timing, so option C is wrong.
  6. Option B swaps the labels, so it is wrong.

Answer: A. The tobacco exclusion is a unique circumstance and the prudent-investor standard is a legal and regulatory factor.

Exam tips

  • Memorise RRTTLLU and know that return and risk (the first two letters) are objectives, so they never appear as constraints. The constraints are TTLLU.
  • When a stem gives a date and an amount, think liquidity. When it gives years until retirement or a goal, think horizon.
  • Expect questions that ask you to classify a client fact. Decide whether the source is the law, the tax code, the client's own wish, or cash flow.
  • For tax cases, compare after-tax returns rather than pre-tax numbers when a tax rate is given.
  • With three options, eliminate any choice that breaks a stated constraint, even if it sounds sensible in general.

Practice questions from Basics of Portfolio Planning and Construction

Investment Constraints in other exams

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

Investment Constraints: frequently asked questions

What are the investment constraints in an IPS?

They are time horizon, tax concerns, liquidity, legal and regulatory factors, and unique circumstances. Each limits the assets a client can hold. The IPS records them next to the return and risk objectives.

What is the difference between liquidity and time horizon constraints?

Liquidity is the need for cash, planned or unexpected, and how fast assets can be turned into cash. Time horizon is the length of time until the money is needed. A client can have a long horizon and still have a large near-term liquidity need.

How does time horizon affect portfolio construction?

A longer horizon generally gives more ability to take risk and hold less liquid assets. A shorter horizon pushes the portfolio toward stable, liquid assets. Multistage horizons need different treatment for each stage.

Is RRTTLLU the same as TTLLU?

RRTTLLU is the full memory aid: Return and Risk objectives, then the five constraints. TTLLU is just the last five letters, which are the constraints. In an exam, only those five are constraints.