Various financial needs lead individuals to seek and make investment decisions. These investments are tempered both by the time horizon for the fulfillment of the objective and the investors own sense or profile on risk assumption. The construction of investment portfolios must consider the individual investors traits and finds a subjectively defined optimal solution. The optimal solution is the determination of a proportional allocation of the wealth of the client among various asset classes such as stocks, bonds, cash, real estate, commodities, currencies, etc. This decision is known as an asset allocation decision.

Since investor objectives are different for each investor, the structure of each investor’s portfolio should also differ. Methodologies exist by which each investor’s objectives and risk preferences are matched with sets of suitable investment opportunities. In doing so, the construction utilizes the interrelationships between different securities as well as the expected return and volatility of each of the individual securities. Statistical techniques, tempered by the qualitative characteristics of investors are used in the construction. The right of every investor is to ask for an explanation from their advisor as to why the suggested portfolio is the one suited best for him or herself – to understand how and why certain statistical properties of assets and securities are combined with the subjective risk tolerance and investment objectives of the investor - to be able to appreciate why the suggested portfolio is cohesive.

Portfolio construction also must address two important constraints: those of liquidity and tax. Liquidity is measured by the ability of the investor to convert an investment into cash within a relatively short time at its fair market value or with a minimum capital loss on the transaction. Most financial assets provide a high degree of liquidity. Most stocks of large companies and bonds of large companies and the government can generally be sold within a matter of minutes at a price reasonably close to the last traded value. Such may not be the case for real estate. Almost everyone has seen a house or piece of commercial real estate sit on the market for weeks, months, or years.

Liquidity can also be measured indirectly by the transaction costs or commissions involved in the transfer of ownership. Financial assets generally trade on a relatively low commission basis of perhaps 1 or 2 percent, whereas many real assets have transaction costs that run from 5 % to 25 % or more. In many cases, the lack of immediate liquidity can be justified if there are unusual opportunities for gain. An investment in real estate or precious gems may provide sufficient return to more than compensate for the added transaction costs. Of course, a bad investment will be all the more difficult to unload. Investors must carefully assess their own situation to determine the need for liquidity. If you are investing funds to be used for the next house payment or the coming semester’s tuition, then immediate liquidity will be essential, and financial assets will be preferred. If funds can be tied up for long periods, bargain-buying opportunities of an unusual nature can also be evaluated.

Investors in high tax brackets have different investment objectives than those in lower brackets or tax-exempt charities, foundations, or similar organizations. An investor in a high tax bracket may prefer municipal bonds (interest is not taxable), real estate (with its depreciation and interest write-off), or investments that provide tax credits or tax shelters.

Though tax considerations should not be the primary consideration for investment decisions, all investors should seek to minimize the tax implications of investment outcomes through deferral or via favorable tax treatment (e.g. long-term capital gains tax rates vs. short-term capital gain tax treatment). Tax payers seek to defer gains during high income years and to accept deductions (losses) in these same years. Conversely, investors will capitalize on investment gains in otherwise lower income years and defer deductions (losses) if possible during these very same years.