The word ‘pyramid’ is largely associated with the ones constructed in Egypt. It gives people the reason to invest big in a passion or cause that the world will remember and keep alive even after you pass away.
However, when it comes to the world of finance, the pyramid doesn’t stand for exuberance. It stands for restraint and practical thinking. So an investment pyramid is a portfolio strategy that divides assets depending on the relativity of risks involved in those investments. The bottom of the pyramid features low-risk investments, the middle contains the growth investments and the top is all about speculative investments. Determining the risk of an investment depends a lot upon its variance of the return.
The widest part of the pyramid is naturally at the bottom, so it would consist of government bonds and money market securities. Stocks and shares would be in the middle while above would feature options and futures.
Many smart investors or financial advisors would often go for investing 40-50% of their money available at the bottom. This is even more valuable when the situation demands the investor to play it safe.
The middle offers a much stable return and a wider possibility of capital appreciation than the other two. So apart from generating more income, these investments grow in value themselves. For instance, a good growth stock gives income in the form of annual dividends and the value of the stock itself rises.
While they say it is lonely at the top. This is true even for the investment pyramid in stock markets. You need to spend less there but the reverse is only possible if you have nothing to lose as such without grave consequences.
This pyramid strategy has two major aims. One is to manage the investor’s average cost in the stock smartly. And two, limiting the amount of new capital the investor exposes to risk. So, this technique isn’t necessarily meant for novice investors or those who want to put in very small amounts of money.
However, this is much like playing a game of cards. The more practice one gets doing it, the more experience one achieves, making it possible for them to go deeper and bigger in investments. As a result, the stock has to be moved in stages. Only then can an investor be confident in rotating capital out of different stocks that may not be performing that well as per expectations and into those that are the most sought after or favored as the market continues to go on an upward trend. But all this has to be done while having a lookout at the average cost at the same time.
The simple definition of an average cost is the total cost per share of a stock. Here, the investor must be careful and control their instincts. The higher the price of the share bought, the higher the average cost and as a result, profit margins are likely to reduce more so when the stock is pulled back.
