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What is the investment pyramid? Here are the basics

At a glance:

  • Investment pyramid base: Set goals

  • Middle of the investment pyramid: Manage saving and spending

  • Top of the investment pyramid: Asset allocation

  • Summary of the investment pyramid

Do you remember the U.S. Department of Agriculture's food pyramid?

Even though the USDA abandoned the pyramid as an image to help set dietary priorities, it's still a useful shape to convey how to allocate your time and resources, including when you're investing.

At the bottom of the pyramid are the activities that you should spend the most time and energy on because they have the biggest impact on your results.

They're the equivalent of broccoli and brown rice. Meanwhile, at the top are tasks that, though worthwhile, will have a smaller impact on your bottom line.

Here's a look at one investment pyramid, ranging from what should be investors' top priorities—the base of the pyramid—to the least important ones.

If you have a finite amount of time to devote to your investment activities, this can help guide the way.

Trader Peter Tuchman wears a DOW 29,000 hat on the floor at the New York Stock Exchange (NYSE) in New York, U.S. on Jan. 15, 2020. (Photo: REUTERS/Brendan McDermid TPX IMAGES OF THE DAY)
Trader Peter Tuchman wears a DOW 29,000 hat on the floor at the New York Stock Exchange (NYSE) in New York, U.S. on Jan. 15, 2020. (Photo: REUTERS/Brendan McDermid TPX IMAGES OF THE DAY)

Investment pyramid base: Set goals

You know how it is when you don't start a day with a to-do list? You get buffeted around by whatever comes up.

Phone calls, answering emails, chatting with colleagues about favorite childhood candy bars, and whoops—how on earth did it get to be 11:20 already?

At the bottom of the investment pyramid are the activities you should spend the most time and energy on because they have the biggest impact on your results.

What happens when you don't set goals

Managing your finances without first articulating your near- and long-term goals is pretty similar.

The days will go by, and you'll no doubt find plenty of ways to spend your money. But you won't necessarily get to where you really wanted to go.

Rather than operating with the amorphous goal of "wealth accumulation," take a step back and articulate the specifics of what you're trying to achieve, when you'll need the money, and how much.

What happens when you set goals

Paying the full freight for college for each of your kids? Retirement while you're still young enough to enjoy it? A move to a bigger house within the next five years?

By quantifying each of your financial goals, you may see that it's not going to be possible to achieve them all, but it's better to know that early on so you can prioritize.

And each of those goals likely carries its own time horizon, which in turn will dictate what types of investments you hold and where.

Once you've set your baseline goals and quantified how much they'll cost, checking your progress toward them can serve as the ultimate financial checkup; monitoring specific investments is secondary.

Middle of the investment pyramid: Manage saving and spending

Budgeting is boring, which is why it's easy to give short shrift to it in favor of sexier pursuits such as trading stocks.

But even if you select the very best investments, you'll be hard-pressed to make up for a shortfall if you haven't saved enough.

That's why setting your saving and spending rate has far more importance in the investment pyramid than does investment selection (i.e., asset allocation).

Let the technology help you

As a result of technological advances and new electronic budgeting tools, there have never been more ways to monitor and manage your spending.

This is key to ensure that your savings rate puts you on track to achieve the above-mentioned goals.

For people who prefer the pen-and-paper route, you can find budgeting worksheets online.

You still need to budget once you've stopped saving

Note that this concept matters long after you've stopped saving, too.

For retirees, the difference between a 4% and a 6% withdrawal rate can be enormous when it comes to the viability of a retirement plan.

Being able to adjust one's spending rate—especially downward in times of market duress—has also emerged as a best practice in the realm of retirement portfolio management because it helps a retiree avoid turning paper losses into real ones.

Top of the investment pyramid: Asset allocation

For more than 25 years, academics have been debating the role that asset allocation—a portfolio's division among stocks, bonds, and cash—plays in investment results.

Specific findings have varied, but there's near-universal consensus both in the academic community and among practitioners that the asset allocation mix you choose matters a lot.

A portfolio that consists entirely of cash and short-term bonds will exhibit very few fluctuations, which can provide peace of mind and may be appropriate for very short-term goals.

Over time, however, it will get eaten alive by a portfolio that includes a stock component.

The basic rules

Specific recommendations about asset allocation will vary by advisor and financial-services company, but the basic rules of the road should hold you in good stead during your investing career.

For your long-term goals, advisors usually recommend the following: start heavy with high-quality stocks, then gradually shift more into safer securities as your need for the money draws near.

And be careful not to gorge on niche investments such as gold and emerging-markets stocks, whose returns are sometimes explosive, but so is their downside potential.

Diversify reasonably among the core asset classes—high-quality stocks, high-quality bonds, and cash—and you'll be OK.

Summary of the investment pyramid

Like the old food pyramid, the investment pyramid starts with a base upon which to build a strategy. And as with any worthwhile endeavor, it starts with setting goals.

Only by doing that can you properly direct the activities of the other bands of the pyramid.

This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.

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