Three-spoke Rule: Investing with the Three-spoke Rule
Many financial experts say that you don’t get rich by just saving. Your money needs to work for you. Another way of looking at it is making money from money. And that’s where an investing rule called the three spoke rule or “drei speichen regel” comes in.
You don’t invest based on whims. Some experts have dedicated their whole lives to fine-tuning their strategy. Fortunately, you don’t have to do it the hard way to learn the right strategies.
I’ll dive deep into everything you need to know about the three-spokes rule, where it comes from, the variations, and more. One thing is certain, you’ll come out wiser and know more about investing after reading this complete and in-depth guide. So, let’s get started.
Table of Content
To become an expert, you need to start somewhere. It’s always best to start from the beginning. So, what is the three-spoke model? In German, it’s the drei speichen modell.
An investing model is best for protecting your money. It helps you know what the right strategies are. And most importantly, you’ll know how to go about investing. It’ll give you a framework for all the decisions you make.
You can think of this investing model as that. It’s a framework or a rule for investing smartly. In essence, the whole idea of the drei speichen regel is about distributing your assets. And you might have guessed it already, you distribute them into three classes or asset buckets.
You keep 1/3rd of your assets on hand. This one is pretty easy to understand. This is where your assets are most liquid. You have the easiest access to your asset when it’s on hand. The other 1/3rd will go towards merchandise.
What about the remaining 1/3rd? What do you do with that? You invest that in land. This golden rule has been around for a long time. And in many cases, people benefitted from this awesome tried, and true strategy for safeguarding your assets and making your money generate more money.
As I mentioned before, this is your most liquid form of asset. And it’s the first asset class of the three-spoke rule. It’s accessible at all times. And you use it whenever you want. There’s no need to liquidate your assets in any way. You can think of it as cash on hand. Pretty self-explanatory.
In the three-spoke rule or 3 speichen regel, 1/3rd going to merchandise might seem confusing. Well, merchandise simply means goods. It doesn’t get any more straightforward than that.
You can break these into subcategories as well. It could mean stocks or investing in companies. If you think about it, it makes a lot of sense for today’s market. There are tons of hyper-successful billion and even trillion-dollar companies.
It’ll be quite hard for a savvy investor who understands the market to pass up on this. Many people have become millionaires just from the value of their shares in large companies. Now, of course, there are natural risks involved. That’s just how investing works. More on this a bit later.
The other way of interpreting merchandise, or goods, can be precious metals. It could even mean gold and other precious commodities.
Land is real estate, plain and simple. You could argue that investing in real estate and land is one of the safest bets. It can give substantial returns on your investment. It’s safe, too. The English translation of the drei speichen regel states to ‘bury your money in the ground.’ I don’t think that’s literal.
It’s a way of saying to invest in real estate and land to keep your money safe. Safety is, of course, a big priority when it comes to any investment. As I mentioned earlier, you can’t guarantee safety in any kind of investment. But you can be smart and calculating about it.
In a way, you taking the time to read this guide is a form of being smart and calculating about your investments to make the most out of them.
Before you go on distributing your assets, wait! There’s a bit of housekeeping that needs to be done. You need to understand the fundamentals here. Here’s some golden advice for beginners regarding the three-spokes rule.
Investing is a risk. Sometimes you might get a huge return. And other times your investment might turn out to be a complete dud.
That’s why you should always spread the risk. And that’s the whole idea behind drei speichen regel. The risk can be distributed between land/property, gold, and securities like stocks.
Some people might be a bit skeptical about putting so much of their money into gold when they first learn the three-spokes rule. Well, it’s not as counterintuitive as you might think, even in today’s market. Gold primarily acts as a form of wealth protection.
Some asset classes will gain value. Others can naturally lose their value. When economic uncertainty is looming, gold can make sense for a lot of people, even for entire countries, for that matter.
Alright, let’s get into some interesting history about the three-spokes model. It’s pretty interesting and dates back to the fourth century. You’ll appreciate the whole concept even more once you know how it started and where it came from.
The idea of the model came from the Jewish Talmud. Instantly, that tells you how deep the roots are. It can be dated way back to the fourth century AD. It’s been a successful investing rule for many since then.
And you can be sure that since it has been around for so long, it’s tried and tested. The drei speichen regel will become clearer as we dive into other topics. Speaking of which, let’s check out the variants of the three-spokes model.
Now, don’t think that the drei speichen modell or the three-spoke rule is outdated. It isn’t one bit. The lessons are timeless and very transferable to modern day.
For something that’s been around for so long, you can expect there to be variations. And you’d be right. There are different variants of the three-spoke rule. Though, by variants, I don’t mean changes to the underlying or fundamental rule.
I mean interpretations. Since the drei speichen modell has been around for so long, different interpretations are also available. There are four main interpretations of the rule. Some things overlap, while others are a bit different.
Here’s a convenient table for you. I included what the original source says as well as each interpretation of the three-spokes rule.
Money on Hand
Safe custody can be interpreted as government bonds. It makes sense in a way. Perhaps your money is safest in a bond.
But it can also be interpreted to mean real estate. It doesn’t stop there. Cash can also be interpreted as gold. This is in the case of the third interpretation of the drei speichen regel aktuell.
To be more specific, it could have been replaced by gold. In the early days, it wouldn’t have been uncommon to see gold used the way cash is today.
The fourth interpretation is a bit out there, and it’s the most unconventional. Goods are interpreted as commodities. Safe custody is interpreted as shares. In other words, business. You need to take these as what they are.
These aren’t changes to the rules themselves. These are just variants or interpretations of the three-spoke rule. And it doesn’t necessarily mean one is right and the other is wrong.
Some of the interpretations are pretty far-fetched though. So, there’s still a possibility of a misinterpretation here, you need to keep that in mind.
To understand the 3 speichen regel and all of its nuances, you also need to know about the magic triangle of investing. No, it isn’t as mystical as it sounds. It won’t magically print money.
Jokes aside, it’s a framework that’ll help you prioritize your investments. So, what is it? And how does it work? Well, from the name you probably guessed it has three components that form a triangle visually:
The thing is, these three are essential goals, but you’ll never be able to achieve all three. That’s where it gets interesting. Whether you’re using the three-spoke rule, or not, the triangle of investment is pretty interesting.
The components themselves are pretty easy to understand. I am sure you know what return means. It’s the first goal of investing. You want to get a return on your investment, of course.
And at the highest interest rate, if possible. Many investors measure return in dividends, interest rates, rental income, price gains, and more.
Then you have security. There is no point in learning to invest the right way with the drei speichen modell and then doing it with high-risk investments. This is in direct conflict with return. Let me first explain what I mean by security here. Basically, the higher the return your investment gets you, the less secure it is.
It really is as simple as that. Now, what does that mean? It’s common knowledge that investments that guarantee returns always have high security, for example, fixed deposits.
No one’s going to argue that fixed deposits aren’t secure. But they provide low returns and can also be eaten up by inflation.
As an investor, you need to play a balancing game here. You shouldn’t only invest in safe investments. That’ll limit your chances of really finding those ‘blow the roof of the house’ kinds of investments.
There’s a flip side to this as well. You also don’t want to invest in something that might have a very high return, but has astronomical risk.
The last component is availability. In simple terms, liquidity. Having some assets invested in liquid funds is always a good idea. You never know when you might need to quickly gain access to those on a rainy day, so it’s pretty important to keep it handy.
As a general guideline, two to three months of income/salary is a good starting point. It’ll give you some flexibility and will allow you to have some immediate liquid assets on hand.
I already told you the most important rule. You can never achieve all three components. An investment might be very secure and available, but it’ll have low rewards.
Another investment can be high reward and available. But in that case, it’ll be less secure and risky. Are you seeing where I am going with this?
You need to sacrifice at least one of the components. Depending on your investing strategy and what you invest in, your investment can only achieve two of the three components simultaneously.
There is another lesson here too. If someone comes to you and tells you that they have an investment idea that guarantees high reward, low risk, and availability, that’s a huge red flag. You’ll immediately be able to catch this fraud. Make sure to stay away from that.
These are the most common types of accounts. Who doesn’t have a current account at a bank somewhere?
As you might guess, the return on these is very low. However, security is very high. And they’re very liquid as well. In fact, availability is the biggest advantage for current accounts.
The state will protect your deposits up to a certain amount. This means you don’t have to worry about any security risks.
Shares naturally have very high returns, but high risks as well, making them a high-reward and low-security. Share prices can increase significantly, which can give you high returns.
Then there’s also the whole conversation about dividends. All these are great, but there are no guarantees.
Real estate investments have medium to high yields. And security is medium. But the biggest factor with property or real estate is availability. The availability or liquidity is very low with real estate.
After analyzing the three-spokes rule, we can narrow down five components. So, they would be cash, shares, property, raw material, and top government bonds.
And these can be mapped for ETFs as well. Cash is cash. There is nothing to be discussed here. But, let’s look at the others in more detail.
You can represent shares with a diversified share index that’s indexed globally. ETFs that track the FTSE World Index MSCI ACWI are suitable, as is the 70/30 portfolio. The total expense ratio of iShares MSCI ACWI UCITS is 0.02%. And there is no pouring out.
Next up we have property. Instead of purchasing a house or real estate, it’s best to represent it in terms of a stock index. For this, you have two very good stock options: REITs and real estate stocks.
When representing raw materials or commodities with ETFs, you do it with commodities futures. A good index might be the Bloomberg Commodity Index.
I am, of course, talking about government bonds here. You can map these bonds with ETFs. That isn’t much of a problem. The Bloomberg Euro Bond Index or the Solactive EuroZONE Government Bond Index are two you can look into.
Alright, let’s talk about portfolios. That’s the main goal at the end of the day. Here’s the interesting thing. You can end up with multiple portfolios here. It all depends on how you interpret the three-spokes rule. The return and ratio can be different as well.
For the first portfolio, you’ll essentially have cash, bonds, and a stock portfolio. So, to be more specific, it’ll be cash, the Bloomberg Euro Government Inflation Linked Bond Index, and MSCI ACWI.
As for the second, you’re looking at real estate, cash, and stocks. This means it’ll be FTSE EPRA NAREIT Developed, MSCI ACWI, and cash.
Portfolio 3 consists of commodities, cash, and stocks. To be more specific, it’ll be MSCI ACWI, cash, and the Bloomberg Commodity Index Total Return.
And last but certainly not least, you have portfolio 4. This one consists of gold, real estate, and stocks. Gold price is important here, along with FTSE EPRA NAREIT Developed and MSCI ACWI.
You need to look at historical data to get an understanding of how these will perform. Otherwise, just knowing the 3 speichen regel won’t help much.
Portfolios that have commodities and equities might not perform as well as the others. However, if you’re looking for the best risk-return ratio, then cash, stocks, and bonds are great for that.
But you need to put things in context though. The return isn’t mind-blowing, but respectable given the risk isn’t that high either. All these analyses are pretty important in the three-spokes model.
The interesting analysis is that the portfolio with real estate is very high risk, but the return on is just marginally higher.
And gold, real estate, and equities are the riskiest, but naturally perform the best. It comes in a close second in terms of risk and returns ratio.
So, after seeing all this, what would be the best possible portfolio strategy for three-spokes model investing?
Well, if you followed this guide to here, you’ll know that the whole idea behind the three-spokes rule is to spread the assets into three asset classes. These classes should have nothing to do with each other. That means, one going up or down shouldn’t affect the other.
This is quite important to keep in mind because sometimes you don’t achieve this. So, the thing you should be looking for is a correlation. This tells you the relationship and the movements against the assets.
For example, if one asset’s value goes down and the other’s goes down because of it, there is a strong correlation. The highest correlation you can have is 1. So, the lower the correlation, the better it is. That means, the less the correlation is than 1, the better off you’ll be.
Let me dive into this a bit more. The strategy you need to understand when it comes to your portfolio according to the drei speichen regel aktuell or the three-spokes model is that you need to create a portfolio with unrelated or uncorrelated assets.
This will give you the highest chance of distributing your assets in different asset classes, which means you’ll reduce your risk. It’ll help you spread the overall risk evenly.
And if an asset class sees a bad period, you’ll have two other classes that’ll be doing well. Plus, since the correlation is low, ideally, they shouldn’t be affected by that one asset class devaluing.
If you’re using the three-spoke rule, creating the best portfolio will become easy and it’ll give you the right kind of portfolios to invest in. That’s the beauty of the 3 speichen regel. It gives you all the tools and know-how you need to do it.
Apart from this model, you should always keep the common portfolio management best practices in mind. Don’t think that this model is the be-all, end-all of investment. Yes, it’s super effective and gives you a framework to work with.
But it’s a framework. It’s just a tool. A tool that you’ll use to make the right decisions. So, all common rules and strategies like stop losses, dividends, principal protected notes, diversification and market timing still apply.
These things are the basic foundations of investing and portfolio management. You should use the model as a supplement.
A way to elevate your strategy and make it more effective. Invest smartly and always do the groundwork, which involves research. The good thing is that with this rule, you’ll hit the ground running.
And that’s very important. It’s always good to have some kind of rule to work with. Otherwise, you might just be making decisions based on gut feelings. And when investing your hard-earned money, that’s a big no-no!
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Alright, there you have it. Now, you should have a complete and in-depth idea about everything related to the three-spokes rule. Remember that this rule is just that, a rule and framework to help you make better decisions when it comes to investing.
But it doesn’t mean that you should just follow it blindly. This rule will help you create a very carefully planned portfolio and give you general guidelines on how to invest the right way! The 3 speichen regel is a tried and trusted rule for investing that puts things in a new perspective.