How the investment triangle helps you decide on an investment
Traders choose assets to invest in based on a proven strategy, experience, and personal preferences. However, it is difficult for a beginner to take the first step, especially if there is no knowledge to lean on. In this case, the best solution is to analyze each asset using the investment triangle.
The concept is based on three basic parameters that should be relied upon when choosing an instrument – profitability, liquidity, and reliability. Their interdependence is shown as a triangle for clarity. For example, in the case of a short-term investment strategy, an investor is primarily looking for an opportunity to convert assets into money, i.e. to achieve liquidity within a short period of time. At the same time, it is essential for him to preserve the invested funds, which requires the choice of a highly reliable instrument. However, in these conditions, yields will be low. Government bonds meet these criteria and offer high reliability, but relatively low returns.
In the case of long-term investments, it is possible to obtain a high yield and reliability of the instrument. At the same time, there are often problems with liquidity, although, in the long term, this parameter does not play a big role. In this case, various funded pension programs are chosen.The investment triangle is a fairly common way to quickly evaluate an asset using only three characteristics. There is also an alternative approach that uses categories as parameters that affect the possibility of achieving the goals set. We are talking about the level of risk, the initial capital, and the investment horizon. In this variant of the triangle, to shorten the period of achieving the goal, it is necessary to increase the investment volume or choose risky assets.
If an investor needs to minimize risks, he will have to increase the time to reach the goal or invest a larger amount. It is possible to achieve high profits with limited capital by changing the investment period or using high-risk instruments.
A diversification strategy is considered the optimal solution for generating income while reducing risk. For example, by investing in stocks and bonds, you can achieve a good level of reliability, but the return will be lower than if you invest only in stocks. If it is important to choose a liquid instrument that provides reliability, then it is better to pay attention to a bank deposit or invest money in bonds of a company with stable performance.
You should understand that you can’t get perfect reliability and liquidity with a high return. When investing in any asset you will have to sacrifice some parameters. In this case, it is important to understand what is the most important characteristic for you and then choose the right instrument.