The Pyramid: Ordering Your Investment Objectives
The Pyramid: Ordering Your Investment Objectives
Investment planning is not like trying to win the lottery — it’s not a matter of luck.
Crafting an investment strategy requires an assessment of resources, development of objectives, analysis of choices and opportunities, and, finally, matching of those alternatives to long-term goals.
1. Safety and security of the principal
The most basic investment objective is the safety and security of the principal. When this is the paramount concern, the investor is less concerned with return on investment than with the return of investment. Investments that offer the least investment risk pyramid also carry the lowest expected investment return.
The next objective is income. In an investment portfolio, income comes from interest and dividend payments. Investments that offer relatively more current income generally have less potential for growth in value.
Growth is the objective that appeals most to investors who are accumulating capital for a future need, such as education or retirement funding. With higher growth potential come higher risks and a greater chance of incurring an investment loss.
2. Arranged in a Pyramid
These objectives of investment may be arranged in a pyramid. The safest investments are at the base of the pyramid, and as one climbs up, the choices have greater potential reward, and also greater risks. At the top of the pyramid is speculation, which involves more exotic investments designed in part to outguess the financial markets.
Each element of the pyramid of objectives has a corresponding investment choice. The safest investments are cash equivalents, such as money market funds and short-term government debt. As fthe markets move up and down, the interest earned by such investments will vary, but the underlying value of the principal will be stable.
Government and corporate bonds pay more income, but also involve two risks. One is the risk of default, that is, the chance that the interest or principal will not be paid because of the bankruptcy of the borrower. The other concern with bonds is an interest-rate risk. When interest rates rise, the value of bonds falls, and longer-term bonds fall more sharply than intermediate-term bonds do. If the bond is held to maturity, this paper loss is of no concern, but if the investment must be liquidated prematurely, the paper loss can become quite real. Conversely, of course, if interest rates fall, the value of the bonds will rise, which can lead to handsome gains.
Common stocks have been the most reliable investment choice for those seeking significant capital growth over the long term. This large investment category can be sliced and diced in a variety of ways: growth stocks vs. value stocks, large companies vs. small companies, cyclical stocks vs. noncyclical stocks.
At the top of this pyramid come investments in stock options, venture capital and precious metals. These are choices better left to the most sophisticated investors, who can afford heavy short-term losses as they pursue their investment strategies.
Building your portfolio
The precise balance among stocks, bonds, and cash that will be appropriate for you depends upon your investment strategies. Ask yourself these questions:
• How soon will you need to draw upon your investments? The longer your time horizon, the more weight you should give to stocks. With time on your side, you can afford to ride out the occasional downdrafts. On the other hand, if you expect to begin drawing on your investments in the intermediate term, you should consider shifting your emphasis to income and safety of principal investment objectives.
• How concerned are you about inflation? The greater your concern, the more you should invest in stocks.
• How important is it that your investments not drop significantly in value? If wide price variations are likely to keep you up at night, you should be emphasizing bonds and income-oriented investments.
• Are your investments a source of emergency funds? A cash reserve is a good idea for emergencies, so you don’t have to liquidate investments during adverse market conditions. It’s important not to take your investment planning for granted. Once you’ve decided on a strategy, give it an annual checkup, to be certain that you’re staying on course.
Subscribe our YouTube Channel for more updates.
Top Tips to Remember When You Can’t Pay Business Taxes
Business taxes can be a nightmare for a lot of companies; especially small businesses that are trying to stay afloat. Things can get even tougher when it comes time to file your return and you end up on the wrong side of the ledger. So what should you do if you end up owing more…
First Half of Current Fiscal Year a Record-Breaker for U.S. Treasury
It’s been another record year for the federal government so far, which is in the midst of its current fiscal year. At the end of March, when the government reached its halfway point of the 2016 fiscal year, it had already collected $1.48 trillion. One might think that this massive haul would help ease the…
Why Is Almost Half the Country Paying no Federal Income Tax?
One of the biggest tax debates that will likely always exist is whether or not the nation’s wealthy are paying enough in taxes? It’s easy for some to argue that they don’t but there are many factors that must be considered. Plus, all the while, nearly half of the country’s would-be taxpayers don’t actually pay…
Where Is Your Paycheck Going?
While many of the nation’s high net-worth individuals make much of their income through capital gains, those who still collect a paycheck are doling out of cash to the IRS every time they get paid. The same is true for all taxpayers no matter what income level they fall in. In fact, according to a…