The Rainbow

The world is full of color, but I keep referring to questions as being “gray”. So, lets add some color! My Senior Thesis in college for my design degree was actually on Color Theory. So, let’s do this!

We all know the Rainbow; ROYGBIV or Red, OrangeYellow, Green, Blue, Indigo, and Violet(Purple) (Indigo isn’t really there, seven is just cooler than six, otherwise what about cyan and teal…). We know there is Red, and then Orange. So where does Red end and Orange begin? Where is the line in the rainbow, that differentiates what is Red, from what is Orange?

Investments, suitability, risks, and recommendations all fit within their own Rainbow Analogies.

There are not neat little buckets to put these things. I cannot tell you which is necessarily more aggressive, a large cap stock or an awful junk bond. I know that Large Cap is a MORE conservative equity, and junk bonds are MORE aggressive debt, but there aren’t computations or iron-clad rules to know exactly where they each fit.

The Rainbow

We could try and describe investments on a scale, with US Government Treasury Bills generally being considered the most conservative and safe investment in the world as the darkest Red. We could then try and imagine the most aggressive scary risky investment as the darkest Purple. We could also simply think of hedge funds or sector funds as Purple, or whatever we want to consider the most aggressive.

Think of where things might fit. We could say that corporate bonds are Yellow. Now the better the credit, the more those bonds are being pulled to the Red. The worse the credit, the more the bonds are being pulled to the Purple. If the bonds have guarantees from another company, that also would pull it more to the Red. If these bonds had some other form of guarantee or collateral that also pulls it to the Red.

We could say that common stock is Green. The smaller the stock, the more Purpleis pulling on it, while the larger, the more Red is pulling on it.

We can apply this to Preferred stock too. Straight preferred stock fits wherever it does (again, these are just examples), and the more benefits to the investor the more Red it goes. Cumulative, Participating, and Convertible all give the investor additional protections, making the overall investment more Red . Callable puts more benefits to the issuer and thus is pulling the investment more Purple.

This applies to Risks as well. The more Red the investment, the more conservative. Same as the more conservative an investment, the more Red it is. The opposite holds in that the more risks the investment has, the riskier the investment is the more Purplethe investment is overall. The reverse holds as well, such that the more Purplethe overall investment, the risker.

As we know, Risk and Return are intertwined. So it also holds, the more Red the investment, the less the investment is likely to return. The more Purplethe investment, the more the investment is likely the return. The more Red, the lower the return, the more Purple, the higher.

 

Updated: 4/28/2017