Investment Pyramid
An investment pyramid, or risk pyramid, is a portfolio strategy that allocates assets according to the relative risk levels of those investments. 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 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. 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. An investment pyramid, or risk pyramid, is a portfolio strategy that allocates assets according to the relative risk levels of those investments.
What is an Investment Pyramid
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.
Understanding the Investment Pyramid
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.
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.
Risk Pyramid. Image by Julie Bang © Investopedia 2020
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 tolerance and 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.
Related terms:
Barbell
The barbell is an investment strategy often used in fixed-income portfolios, with the portfolio split between long-term bonds and short-term bonds. read more
Capital Growth Strategy
A capital growth strategy seeks to maximize long-term capital appreciation of a portfolio via an allocation geared to assets with high expected returns. read more
Certificate of Deposit (CD)
A certificate of deposit (CD) is a bank product that earns interest on a lump-sum deposit that's untouched for a predetermined period of time. read more
Diversification
Diversification is an investment strategy based on the premise that a portfolio with different asset types will perform better than one with few. read more
Futures
Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and price. read more
Government Bond
A government bond is issued by a government at the federal, state, or local level to raise debt capital. Treasuries are issued at the federal level. read more
Growth Investing
Growth investing is a stock-buying strategy that aims to profit from firms that grow at above-average rates compared to their industry or the market. read more
Money Market
The money market refers to trading in very short-term debt investments. These investments are characterized by a high degree of safety and relatively low rates of return. read more
Rebalancing
Rebalancing involves realigning the weightings of a portfolio of assets by periodically buying or selling assets to keep the original asset allocation. read more
Risk-Seeking
Risk-seeking is an acceptance of more economic uncertainty in exchange for potentially higher returns. read more