An investment pyramid, or risk pyramid, is a portfolio strategy that allocates assets according to the relative risk levels of those investments. The risk of an investment is defined in this strategy by the variance of the investment return, or the likelihood the investment will decrease in value to a large degree.
The bottom and widest part of the pyramid is comprised of low-risk investments, the mid-portion is composed of growth investments, and the smallest part at the top is allocated to speculative investments.
Key Takeaways
The investment pyramid is an asset allocation strategy that investors use to diversify their portfolio investments according to the risk profile of each security.
The pyramid, representing the investor's portfolio, has three distinct tiers: low-risk assets at the bottom such as cash and money markets; moderately risky assets like stocks and bonds in the middle; and high-risk speculative assets like derivatives at the top.
The strategy calls for allocating the largest proportion of capital to the low-risk assets at the bottom, and the smallest amount to the speculative assets at the top.
An investment pyramid strategy builds a portfolio with the lowest risk investments as the base, equity securities of established companies as the middle, and speculative securities as the top.
The base (i.e. the widest part of the pyramid) would contain the highest allocation of assets and would include cash and CDs, short-term government bonds, and money market securities.
The middle part of the pyramid would include a moderate allocation to corporate bonds, stocks, and real estate. These assets are somewhat risky and have some probability of losing value, although over time they have positive expected returns.
The top would include the smallest allocation weights and include highly risky, speculative investments that have a high chance of loss, but may also produce above-average returns. These would include derivatives contracts like options and futures (not used for hedging purposes), alternative investments, and collectibles such as artwork.
Within each risk layer of the pyramid, you see an increase in risk taking, but with a smaller allocation of overall funds available to invest. As a result, the higher you go up the pyramid, the greater the risk, but also greater the potential return.
Note that not all investors have the same willingness and/or ability to take on risk. The pyramid representing a portfolio should be customized to an individual's particular risk preference and financial situation.
Example of an Investment Pyramid
As an example, Harold went to his financial advisor for advice on how to position his portfolio. The advisor suggested that based on Harold's goals, risk toleranceand time horizon, he should adopt an investment pyramid strategy. The advisor suggests that Harold put 40-50% of his portfolio in Treasury bonds and money market securities, 30-40% in mutual funds that invest in corporate stocks and bonds, and the rest in speculative items such as futures and commodities.
An investment pyramid, or risk pyramid, is a portfolio strategy that allocates assets according to the relative risk levels of those investments. The risk of an investment is defined in this strategy by the variance of the investment return, or the likelihood the investment will decrease in value to a large degree.
The greater the risk of an investment, the higher up the pyramid it goes and, thus, the less money you should put into it. At the very top of the pyramid go the investments that few people should try, such as penny or microcap stocks, commodity futures contracts, promissory notes and most limited partnerships.
Pyramiding involves adding to profitable positions to take advantage of an instrument that is performing well. It allows for large profits to be made as the position grows. Best of all, it does not have to increase risk if performed properly.
The pyramid is an asset allocation tool that investors can use to diversify their portfolios according to the risk profile of each security type. Located on the upper portion of this chart are investments that have higher risks but might offer investors a higher potential for above-average returns.
Pyramid Scheme: The scheme leader(s) take small initial investments from investors, then encourage them to earn money by recruiting new investors. Some of the money gained from new investors is given to previous investors and the scheme leader(s).
A pyramid scheme is a business model which earns primarily by enrolling others into the scheme, however rather than earning income (or providing returns-on-investments) by sale of legitimate products to an end consumer, it mainly earns by recruiting new members with the promise of payments (or services).
The key to successful pyramiding is to always maintain a proper risk to reward ratio, which says that your risk can never be greater than half the potential reward. So if your profit target is 200 pips, your stop loss must be no greater than 100 pips. This achieves a 1:2 risk to reward ratio, also known as “2R”.
The base of the investment risk pyramid, which is the bulk of total assets, contains low-risk assets and accounts. Investments such as government bonds, money markets, savings and checking accounts, certificates of deposit (CDs), and cash are included in the base.
High-risk investments are those that have a greater chance of losing money than other types of investments. They often offer the potential for higher returns, but they also come with a higher risk of loss—for Example, cryptocurrencies, venture capital investing, Alternate Investment Funds, and Forex trading.
For example, one old rule of thumb that some advisors use to determine the proportion a person should allocate to stocks is to subtract the person's age from 100. In other words, if you're 35, you should put 65% of your money into stocks and the remaining 35% into bonds, real estate, and cash.
What is Asset Allocation? Asset allocation refers to an investment strategy in which individuals divide their investment portfolios between different diverse asset classes to minimize investment risks. The asset classes fall into three broad categories: equities, fixed-income, and cash and equivalents.
If you are a moderate-risk investor, it's best to start with a 60-30-10 or 70-20-10 allocation. Those of you who have a 60-40 allocation can also add a touch of gold to their portfolios for better diversification. If you are conservative, then 50-40-10 or 50-30-20 is a good way to start off on your investment journey.
A Pyramid Scheme is a business model that recruits members via a promise of payments or services for enrolling others into the scheme, rather than supplying investments or sale of products.
A classic example of a pyramid scheme is a chain letter. Recipients are encouraged to add new people to the chain and to also send money or gifts to those at the top of the chain. These are illegal practices and like all other pyramid schemes, 90% of participants will lose money.
Introduction: My name is Gregorio Kreiger, I am a tender, brainy, enthusiastic, combative, agreeable, gentle, gentle person who loves writing and wants to share my knowledge and understanding with you.
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