The magic triangle of investing

In the last article, you learned how differently savings accounts and equity investments have performed over the last 30 years, but also how they have fluctuated. Why is this the case? The so-called magic triangle of investing is a very good explanation. Which three factors are decisive for your investment? How do they depend on each other? As a private investor, what goals can you pursue for your investment at the same time? And which ones can’t? You will find the answers in this article.

The magic triangle

The magic triangle of investment refers to the competing goals of return, availability and security when investing. The illustration below symbolizes these three goals with the corner points of the triangle.

Yield: The yield describes the return that results from an investment in an asset. Income can usually be generated through dividend payments, interest payments or increases in value (price gains).

Availability: The availability, often also referred to as liquidity, of an investment expresses how quickly an invested amount can be “liquefied” back into cash or bank deposits. The shorter this conversion period is, the more liquid the investment is. Any (penalty) costs resulting from the conversion must also be taken into account.

Security: Security refers to the preservation of assets. Greater security can be achieved, for example, by spreading the assets (diversification).

– Partner Offer –

According to our experience and due to the low costs for ETFs, “DEGIRO” is currently a particularly attractive broker (link to DEGIRO review). If you are interested, you can register with DEGIRO via our partner link , which supports our blog.

–– – – – –

Only two goals can be achieved at the same time

The magic triangle illustrates that only two of three goals can be pursued at any one time. Or in other words: the third goal must be neglected.

You can choose from the following three options:

Option 1: Investments with high returns and high availability are less secure

Example “shares”: Shares can yield a high return and can generally be traded daily (high availability). However, the risk of strong price fluctuations significantly reduces the security of these investments.

Option 2: Investments with high availability and high security are less profitable

Example “Bank account”: Cash can be withdrawn daily from a private account. In Switzerland, there is also deposit protection for deposits of up to CHF 100,000 per person and bank. However, as the bank’s assets are not available for a fixed period of time, it can only manage them to a limited extent. This is why the return in the form of interest is low or currently tends towards zero.

Option 3: Investments with high security and high returns are not readily available

Example “medium-term notes”: These fixed-interest securities (also known as bonds) also benefit from deposit protection. However, the interest rates are higher than for private or savings accounts. This is because the investor “parks” his money for a longer term (usually three to ten years) and thus accepts limited availability. This in turn enables the bank to act economically over a fixed period, which it rewards with higher interest rates. Note: We currently consider this option to be less attractive, as the (meagre) interest bonus is disproportionate to the limited availability.

We see crowdlending or P2P lending to borrowers with a high credit rating as an alternative worth considering.

Individual risk profile influences the magic triangle

What your personal magic triangle looks like ultimately depends on your risk profile and the following two questions:

How much risk do you want to take (risk appetite)? And how much risk can you take (risk capacity)?

The first factor is subjective (and influenced by your financial education). The second factor is objective and depends on your financial situation.

An example: If you are planning major expenditure in the next two or three years, e.g. for a home, you will ideally prioritize high availability and security (wealth preservation) for your assets. Even if you are a risk-taker or have a high appetite for risk, it would be unwise to invest riskily in such a situation.

“The dream of a highly profitable, super-fast and 100% secure investment is therefore over. Unfortunately.”

Conclusion

The dream of a highly profitable, super-fast and 100% secure investment is therefore over. Unfortunately. As in other areas of life, we cannot avoid compromises when it comes to investing.

This means that if you want to generate a high return, you either have to have a long investment horizon or accept major compromises in terms of security or take high risks.

In our next article, you will find out how it is still possible to optimize the risk/return ratio by cleverly diversifying your investment. Our series of articles, Learning to invest in eight lessons, offers you a comprehensive introduction to the topic of investing.

This might also interest you

Diversification: not all eggs in the same basket

Asset allocation: the nuts and bolts of your investment

Disclaimer

Disclaimer: Investing involves risks of loss. You must decide for yourself whether you want to bear these risks or not.

Errors excepted: We have written this article to the best of our knowledge and belief. Our aim is to provide you as a private investor with the most objective and meaningful financial information possible. However, should we have made any errors, forgotten important aspects and/or no longer have up-to-date information, we would be grateful if you could let us know.