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An investment pyramid is a visual depiction of the principle that investors should stagger their investment portfolio so that different amounts of money have differing levels of risk. Specifically, the largest amounts of money should be in low or no-risk investments, while increasingly smaller amounts of money are in increasingly more risky investments. This principle generally protects the investor's overall financial security from market shocks and downturns.
The base of an investment pyramid consists of safe, highly liquid, investments, such as savings account balances or short-term certificates of deposit (CDs). The security and easy access investors have to this money usually means that it will have the potential to earn them more money like higher risk and less liquid investments. However, having this large base of readily available money means that the investor will have a ready supply of cash for unexpected expenses. This prevents the necessity of paying the fees associated with pulling money from less liquid investments, or the long-term losses that would come from selling a high-priced stock the investor bought at a low price.
The next step up in an investment pyramid are items such as long-term CDs, government treasury bonds, and bonds from financially stable companies. These investments are considered income, because they pay a fixed interest on the money put into them. The risk of losing money investors put into this level of investment is very low, but CDs and bonds have something called a maturity date. This is the day when these investments have paid out all their interest and investors get back the money they put into the CD or bond. Since there are losses investors incur when they cash out a CD or bond before its maturity date, individuals should plan on not having access to the money put into such investments before their maturity dates.
Stocks and mutual funds have the potential to appreciate in value, and allow investors to sell shares they bought at lower share prices for significant profits. A downturn in the stock market, however, can cause share prices to drop and investors to lose money. Stocks and mutual funds' potential for profit and risk of loss puts stocks and mutual funds at the top of the investment pyramid. This uppermost level continues to follow a pyramidal structure with regard to risk. Most of the money goes into stocks and mutual funds rated as safe investments, with less going into slightly risky stocks, and the smallest amount of money going into very risky investments.
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