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Finance Dictionary and Glossary of Investment Terms
A portfolio strategy that allocates assets according to the relative safety and soundness of investments. The bottom of the pyramid is comprised of low-risk investments, the mid portion is composed of growth investments, and the top is speculative investments.
Some experts urge their clients to visualize their financial needs as a kind of pyramid, with each new level built upon the one beneath it. Building the investment pyramid is a gradual process: As your net worth grows, you move up to the next level, increasing both the amount of risk and the potential for gain.The foundation of the pyramid, known as Level 1, represents basic security needs: a retirement plan, life, health and disability insurance and some cash in a money -market fund or other account that can quickly be tapped for emergencies. Your cash reserve should be sufficient to pay your living expenses for three to six months.In Level 2, you take some more risk -- but not much more. Here you invest in safe, income-producing securities such as Treasury and corporate bonds. You can also purchase longer-term CDs, zero-coupon bonds and tax-free municipal bonds to meet special needs. You stagger the maturity of these items so they mature at different times. For example, you could buy some bonds that will mature when your child is ready to go to college, and a 30-year bond that will mature around the time you will retire. Level 2 also involves the purchase of your first home. It not only is a place to live, but also serves as a hedge against inflation and a means to shelter some of your income from taxes.After all the goals in Level 2 are accomplished, you move on to Level 3, which involves investing for growth. You can now afford to take more risks in the hope of reaping higher gains. Investments that fit nicely into Level 3 include blue chip growth stocks, convertible bonds and conservative mutual funds.Level 3 is also where you invest in rental real estate, which can provide another hedge against inflation. The tax deductions provided by rental property can also help shelter more of your growing income.The final step is Level 4, where you can make relatively risky investments in speculative stocks in the hope of reaping even larger gains. Investments for Level 4 can include options, futures and gold or other precious metals. They may also include speculative stocks -- such as takeover candidates or small companies that are developing hot new products -- as well as high-yield, high-risk "junk" bonds and shares in limited partnerships.