Basic Principles of Investing

Basic Principles of Investing
Basic Principles of Investing
Table of Contents

Key Summary

Understand the core principles of investing and learn how they can help you make smarter financial decisions.​
  • Diversification spreads capital across different investments. 
  • It reduces company-specific risk, but not broader market risk. 
  • Greater opportunities for return generally entail higher risks. 
  • Risk tolerance and risk capacity determine a suitable risk level. 
  • The investment horizon and reinvestment shape long-term outcomes. 

Diversification

Diversification means spreading your capital across different investments rather than relying on a single company, sector, region, or asset class. A portfolio may therefore combine stocks, bonds, and real estate investments from a range of markets and industries.

The aim is not simply to hold many positions, but to choose investments that respond differently to market developments. If one investment loses value, another may remain stable or gain value, helping to limit the effect on the portfolio as a whole. This can reduce company-specific risk, such as the impact of weak results or a failed product. However, diversification cannot remove risks that affect the entire market, including economic downturns or changes in interest rates. Exchange-traded funds (ETFs) offer one way to invest in a broad selection of securities through a single product.

Risk and Return

Every investment combines an opportunity for return with the risk of loss. Returns may take the form of interest, dividends, or an increase in value. As a general rule, higher potential returns come with greater uncertainty and stronger price fluctuations.

The level of risk that suits you depends on both your risk tolerance and your risk capacity.

  • Risk tolerance describes how comfortable you are with temporary losses and market movements.
  • Risk capacity reflects your financial ability to absorb these losses, based on your income, reserves, obligations, and investment horizon.

 

 

The two do not always match: you may be financially able to take risk but feel uncomfortable doing so, or vis versa. Personal circumstances can also change over time. If you plan to buy a home, you may need the money sooner and prefer greater stability. Reviewing both factors regularly can help keep your portfolio aligned with your goals. 

Investment Horizon

Your investment horizon is the period for which you expect to keep your capital invested before you need to access it. Together with your goals and financial situation, it helps determine which investments and level of risk may be appropriate. 

A longer horizon gives a portfolio more time to recover from temporary market declines and allows reinvested returns to accumulate. A shorter horizon leaves less time to offset losses. In this case, preserving capital and keeping funds accessible may become more important than pursuing higher returns. Your horizon can also change as your plans develop. If you intend to buy a home within a few years, for example, money set aside for the purchase should not depend on a short-term market recovery. Defining when you will need your capital therefore provides an important link between your goals, risk capacity, and portfolio structure. 

Compound Interest

Time also shapes the effect of compound interest. It occurs when returns remain invested and can generate further returns. Growth can therefore build on both the original capital and the returns already accumulated. The effect is limited at first but becomes more noticeable over longer periods, which is why starting early and remaining invested can be important.

For example, an initial investment of CHF 1,000 would grow to about CHF 4,322 after 30 years at an annual return of 5%, provided all returns are reinvested. This calculation is illustrative and does not reflect fees, taxes, or changing market conditions. Actual returns are not constant or guaranteed, and investments may lose value. Compound interest is therefore not a promise of a specific outcome. Instead, it shows how reinvesting returns and allowing sufficient time can support long-term capital growth.

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