Basic Principles of Investing

Basic Principles of Investing

Understand the core principles of investing and learn how they can help you make smarter financial decisions.​

Diversification

Diversification means spreading capital across different investments instead of putting all your eggs in one basket. This can mean, for example, not only buying shares in a company, but investing in many different companies, asset classes (e.g. stocks, bonds or real estate) or in different industries (e.g. healthcare, finance, industry or information technology). This reduces the risk that a single loss will be particularly significant. Fittingly, there is the well-known folk wisdom: "Don't put all your eggs in one basket." 

The more diverse your stock portfolio, the lower your unsystematic risk. This is the risk that affects individual companies only, for example if a company reports poor results or a product fails. This is because, while the price of one stock may fall, the price of another may rise at the same time.

This usually balances out the overall effect. This principle is called diversification. However, risk can never be eliminated entirely because there are still influences that affect all companies, such as economic crises or changes in interest rates. This residual risk is called systematic risk. It remains even if you have invested very broadly.

A broad diversification is particularly easy and efficient with so-called ETFs (exchange-traded funds). These are traded on the stock exchange and bundle many different securities – for example, shares from different industries, countries or even entire markets – in a single fund.

Risk and Return

When you invest money, here is essentially what happens:

You deploy your capital with the goal of growing it. You aim for a return—that is, a profit or income in the form of interest, dividends, or a higher selling price for the asset.

On the other hand, there is risk: the uncertainty of whether your investment will perform as hoped. Values can fluctuate, and in a worst-case scenario, you could lose part or even all of your invested capital.

Why are risk and return related?

  • High potential returns usually mean higher risk.
    Example: Stocks of small, fast-growing companies can rise sharply in value, but they can also fall quickly and significantly.
  • Low risk usually means lower potential returns.
    Example: A savings account is secure, but currently offers only low or no interest rates.

You can think of it like a scale. On the one hand there is security, on the other hand the chance of higher profits. The more security you want, the more potential return you generally have to give up—and vice versa.

Risk Tolerance vs. Risk Capacity

The willingness to take risks when investing depends not only on personal attitude, but also on financial possibilities. In this context,  a distinction is made  between risk tolerance and risk capacity:

  • Risk tolerance describes the psychological willingness to endure fluctuations or losses. It varies from person to person and is emotionally influenced: Some people sleep soundly even though their investments fluctuate greatly, while others feel uncomfortable even with small losses. Risk tolerance often depends on experience, security needs and personal goals.

  • Risk capacity, on the other hand, refers to the objective financial opportunity to take risks. It results from factors such as income, assets, obligations and the time horizon of the investment. For example, those who have sufficient reserves and do not need the money invested in the short term have a higher risk capacity.

Ideally, risk tolerance and risk capacity are aligned. In practice, however, it is common for someone to be financially able to bear risk but to struggle with it emotionally—or vice versa.

Example: An upcoming home purchase can influence both aspects. Risk capacity drops because the funds will be needed soon. At the same time, risk tolerance often decreases because emotional security becomes more important. Consequently, risk tolerance and capacity can change over time. Therefore, the investment portfolio should be reviewed regularly, and the equity ratio (stock allocation) adjusted accordingly.

Investment Horizon

The investment horizon refers to the length of time your capital is intended to remain invested before you need to access it.

Generally, the longer your investment horizon, the better you can ride out short-term market fluctuations and capitalize on market opportunities. Taking a long-term view usually offers higher potential returns and makes it easier to recover from risks.

However, personal life events—such as an upcoming home purchase—can shift this horizon. In such cases, your risk capacity (the financial ability to absorb value fluctuations or losses) often decreases. If you know you will need funds for a property purchase within a few years, you should tend to invest more conservatively, focusing on capital preservation and liquidity. This ensures the money is available exactly when you need it

Compound Interest

With the compound interest effect, generated returns are not paid out but are immediately invested again (reinvested). Consequently, in the following period, you earn interest not only on your initial capital but also on the interest that has already accumulated. This effect ensures that your wealth grows at an accelerating rate over time.

An example: An initial investment of CHF 1,000 grows to around CHF 4,322 after 30 years at a 5% annual interest rate—without you having to deposit a single additional franc. However, this requires that returns are consistently reinvested and that the markets perform positively on average

  • Red dashed line: Simple interest rate – interest only on the initial capital
  • Blue solid line: Compound interest effect – interest on capital including interest already earned