Not satisfied with the low-interest rates on your account? However, do you have doubts about where and how it is best to invest your savings? In this article, you will find out what the basics are for successful investing.
You will see how compound interest works over the years and how risk and reward interact with each other. You will learn to evaluate your risk capacity and your propensity for it to work out the perfect investment mix based on your situation.
- Interest rate differentials
- Risk and return
- Your risk profile
- The right investment mix
INTEREST RATE DIFFERENTIALS
The effect of compound interest is often underestimated. However, over a long period, it can transform even small amounts into substantial assets. And it is the main reason why it is worth starting to save at an early age.
When investing, it is, therefore, necessary to pay attention to the minimum interest rate differentials and, above all, also to the costs to be incurred annually. If one financial institution charges you one percent in commissions, while another only charge 0.5 percent, the difference to your assets will ultimately be considerable.
RISK AND RETURN
The link between risk and reward is clear: the higher the long-term return, the higher the risk that needs to be taken into account. In the world of finance, the risk is mainly measured based on volatility, which indicates the fluctuations in the prices of an investment. If you want to get a high return, you need to take into account that your investment can lose value in the short to medium term.
In the long run, however, in most cases, the risk pays off, as the following graph shows: Swiss equities have produced an annual return of just under 12 percent since 1990, compared with a risk of as much as 22 percent. By contrast, investing in Swiss real estate has proven to be a safer strategy: volatility has been around eight percent in recent years. However, real estate yielded annual returns of only 6 percent.
RISK AND RETURN OF VARIOUS ASSET CLASSES SINCE 1990
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It is true that if good earnings have been recorded in the past, the trend will not necessarily be positive for the future as well. However, it is possible to make some long-term forecasts regarding the returns of individual asset classes. Shareholders have almost always done good long-term business so far, even when stocks have repeatedly fallen sharply. Equities will continue to perform better than bonds, but with greater risk. The assumption is that your investment horizon is projected far enough forward.
The differences are not only found between different investment categories, but also within each of them. Here’s an example: In January 2015, when the SNB announced that it would no longer hedge the Swiss franc’s minimum exchange rate of 1.20 against the euro, the SMI, Switzerland’s leading equity index, sank. Shares of exporting companies such as the Swatch Group, which in some cases lost more than 16 percent, were particularly affected. On the other hand, Swisscom’s share performance was completely different: the shares of the telecommunications company, which is mainly active in Switzerland, even recorded an increase of one percent.
The board of Generali
Since as a private investor you cannot know which stocks will perform better over the long term, it is preferable to buy a package of stocks that are well spread across a large number of sectors and countries.
With each additional action, the overall risk is reduced. It is reasonable to invest in at least 12, better yet in 20-30 different stocks from various sectors and countries. When investing only in stocks, however, you always have to deal with the general risk of a stock market crash. To significantly reduce your overall risk, you need to invest not only in equities but also in other asset classes, such as bonds and real estate. In other words: you need to diversify.
The board of Generali
It is not reasonable to buy small shares of individual stocks, as the purchase costs and deposit fees would be too high. Therefore, if you have small or medium-sized assets, the only way to truly diversify is to use investment funds.
YOUR RISK PROFILE
The risk profile is the result of the risk capacity and the propensity for it.
- Let’s start with the risk appetite, which is an emotional factor. Some like the risk. Others, on the other hand, fear it, not only when it comes to investing. In addition, risk appetite fluctuates based on stock market performance. If prices have risen sharply, investors are more risk-prone. After a collapse, however, their willingness to take risks diminishes.
- The risk capacity is a target value. It depends on the assets available, on your experience with investments, and above all on your investment horizon, therefore on the time frame in which you can allocate your resources to this purpose.
The board of Generali
Don’t overestimate your ability to take risks and your propensity for them. If you haven’t been involved in investments so far and the finance pages in the newspapers have never caught your attention, you will likely react disproportionately to fluctuations in prices, causing you to panic at the wrong time. Also, if you are forced to sell your investments at the wrong time due to a critical financial stage, losses will be inevitable.
INVESTMENT HORIZON: THE DECIDING FACTOR
The longer the investment horizon, therefore the time interval during which you have the desire and the possibility to invest your assets, the greater the risk you can take. Thus the possibility of obtaining good returns will also increase. In the short term, stocks can lead to heavy losses. In the long run, the likelihood of this happening is less. While with an investment horizon of one year you have to account for losses of a third (against a chance of gain of 60 percent), over ten years the probability of loss is almost zero, in the face of gains that they can reach 20 percent (see graph).
THE LONGER THE INVESTMENT HORIZON, THE LOWER THE RISK.
THE RIGHT INVESTMENT MIX
The first step is to determine the assets that you will not need in the long term, therefore for at least the next ten years, not even to face large expenses, such as the renovation of the facade, a long training course, or a trip around the world. You also need to create your safety pad. Sufficient liquidity must always be available in the payroll or savings account to release quickly in the event of unforeseen circumstances. Schedule a reserve of at least three months’ salary.
Invest the rest of your assets in bonds, which can be supplemented with real estate investments or commodities if necessary. Also in this case the watchword is to diversify.
DETERMINE THE EXACT INVESTMENT MIX
Each product has its risk profile, which is outlined based on answers to specific questions. The client can contact his / her advisor to fill in the risk profile. Our digital pillar 3a accompanies the customer throughout the online procedure. The questions concern in particular the capacity for risk and the propensity for it. Depending on the product, the customer can change the recommended risk profile by consciously selecting another risk profile and confirming it.
Good to know
Determining your risk profile is even more difficult when you consider that it can vary over time. With increasing age, for example, the risk capacity and the risk propensity tend to decrease. Risk capacity is also affected by private matters, such as marriage, children, divorce, and retirement. Finally, the gains and losses on the stock market can also lead to a change in risk capacity.
We are at your complete disposal for a personalized meeting in which to talk about your needs to find together the solution that is right for you.