- Nancie Grace
Investment According to Theory: Investment Triangle
Following the economic theory, an investment can be seen as forgoing current value for the uncertainty of the future, but with an equitable amount of return reflecting, inter alia, the level of risk, and liquidity. It provides an investor with a general recipe in evaluating his / her present or future assets. When investing according to theory, investor commonly decides in accordance with investment triangle shown in the figure below.
In reference to the investment triangle, the general investor decides on the investment according to three basic parameters: expected return (profitability), the risk assumed (security), and the liquidity of investments (liquidity).
The Investment Triangle
A return is the money lost or made on an investment over some period of time.
In finance, risk pertains to the degree of uncertainty or potential financial loss that is usual in an investment decision. The risk is certainly not zero
Liquidity is the degree to which an asset can be bought or sold quickly in the market at a price reflecting its intrinsic value. Cash considered as the most liquid asset.
The general investor’s behavior is influence by the relationship of three variables. The general investor presumes a higher return on higher risk or a higher risk of higher return. Liquidity then expresses the ability in converting a given investment into a normally convertible asset such as cash in a reasonable time at a certain price. Investors usually decide according to his / her relation to an assumed level of risk. Although the three variables do not represent a definitive effect on the decision making of the investors but these variables are typically in the features of investment.
It has similarities with cars, products, and other services. There’s an old saying about it that you pick two from fast, good or cheap. And the third will be based on whatever it has to be based on the other two choices.
If you want fast service and of high quality, but then it will be very costly.
If you want fast service and cheap, then it will be of low quality.
If you want a service of high quality and cheap, then it will take a long time.
The investment triangle works similarly. For example, you want a high return and high liquidity, but high risk – invest in stocks. You want low risk and high returns but low liquidity – invest in real estate. You want low risk and high liquidity but low returns – invest in bonds.
Remember that correct investment contributes to the future expansion of the investor's assets.
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Business Insider (April 15, 2020). Fast, Good or Cheap – Pick Three? Accessed June 25, 2020 from https://www.business.com/articles/fast-good-cheap-pick-three
Hayes A. (March 24, 2020). A Return in Finance. Accessed June 25, 2020 from https://www.investopedia.com/terms/r/return.asp
Investor US Security and Exchange Commission. What is Risk? Accessed June 26, 2020 from https://www.investor.gov/introduction-investing/investing-basics/what-risk
Chen J. (March 19, 2020). Liquidity. Accessed June 26, 2020 from https://www.investopedia.com/terms/l/liquidity.asp