The investment risk pyramid is an asset allocation tool used by investors to help manage cash flow and diversify their investment portfolio according to the risk associated with each security or categories of securities. Risk pyramids can be broken up into any number of sections, or levels, according to the desired wealth creation preferences of the investor. 
The sample Risk Pyramid includes four distinct levels, each level becoming smaller as it moves towards the top. The base of the pyramid represents the foundation of the pyramid and supports everything above. This base often includes investments that are low risk and provide financial security. These often include a home, insured savings, insurance of any kind and cash, which make up the bulk of your assets. The second level is slightly smaller than the base and represents investments that offer a stable return with relatively low risk. This level often includes low risk mutual funds, high-income bonds, real estate and low risk dividend paying stocks. Although more risky than the base of the pyramid, these investments are still considered to be safe. As we move up the pyramid, the levels continue to shrink in size and so should the cash flow that you allocate to the investments represented. The third level of the pyramid is for investments involving a higher degree of risk and offer greater returns. Again, the greater the risk of any investment, the higher it moves up on the pyramid and the less money you should allocate. In the third level of the pyramid, investments often include growth real estate, junk bonds, stocks and mutual funds. The top of the pyramid, or the peak, is reserved specifically for high risk investments and makes up the smallest section of the pyramid. Any money allocated to high risk investments should be fairly disposable, or money that you can lose without serious repercussions. High risk investments include penny stocks, commodities, futures and collectibles. The specific cash flow allocated to each category of the risk pyramid is not nearly important as the concept itself. Always remember, not all investors are created equally. While one investor prefers less risk, others may prefer more risk. You must define for yourself what you place into each level of your own pyramid. Those who desire more risk can increase the size of their high-risk category by decreasing the size of one or more of the other levels, while those who desire less risk can increase the size of their base. The key to achieving your wealth creation goals is a firm understanding of investment strategies, the relationship between risk and reward, and how they apply to you. Author
Chad Sunyich |
