What you will learn about investing

Learn how compound interest works for you over time. Understand the interplay of risk and return. And learn about how to assess your risk capacity and risk tolerance so you can decide on the right investment mix for your situation.

• Differences in interest rates
• Risks and returns
• Diversification
• Your risk profile
• The right investment mix

Differences in interest rates

Many people underestimate the effect of compounding interest. However, compounding, even in small amounts, can generate considerable assets over long periods of time. It is the main reason why it pays to start saving as early as possible.

Hence, it is important to pay attention to even the smallest differences in returns when investing – and in particular to the costs that your investment incurs each year. If one financial institution charges a fee of one percent, while another only charges half a percent, this will make a big difference to your final assets.
 

Risks and returns

The relationship between risk and return is clear: the higher the expected long-term return, the higher the risk you have to accept. In the financial world, risk is usually measured in terms of volatility, which indicates the degree of fluctuation in the price of an investment. If you want high returns, you therefore have to be able to cope with the fact that your investments may sometimes lose value in the short and medium term.

Nevertheless, the risk usually pays off in the long term. This is shown in the following chart: since 1990, Swiss equities have achieved an annual return of nearly 12 percent – with a risk of just over 22 percent. Swiss real estate was safer with a volatility of 8 percent in the past few years. But the annual return was only 6 percent.
 

Risks and returns of various asset classes since 1990

Higher potential returns usually come with higher risks, as shown by the average figures from 1990 onwards.

Real estate (Switzerland) and bonds (Switzerland, EU) have a return of around 3-6% with a risk of between 5-8%.

Shares (Switzerland, USA, EU) have a return of around 8-12% with a risk of between 20% and 25%. Emerging market shares were more risky, with a risk of 25-40% and returns similar to shares from established markets.

Gold and commodities had returns similar to real estate or bonds, but were associated with higher risks (gold at around 15% risk, commodities around 28% risk, both for returns of 3-4%).

Good to know

While it is true that past profits are not a definite measure of future profits, it is still possible to make some generalisations about the returns of individual asset classes in the long term. In the past, investors have usually done well with equities in the long term, even if securities are often considered a lost cause. Equities will continue to generate higher returns – and entail greater risk – than bonds. The prerequisite for success is that your investment horizon is long enough.
 

Diversification

Different asset classes perform differently, and the same applies within an individual asset class. For example: when the Swiss National Bank announced that it would no longer defend the Swiss franc’s cap of CHF 1.20 against the euro in January 2015, the SMI, the Swiss blue-chip stock market index, plunged dramatically. The shares of export-oriented companies such as the Swatch Group were hit most severely and in some cases lost more than 16 percent. Other shares behaved quite differently, such as Swisscom's: the shares of this telecommunications company, which mainly operates domestically, actually increased by 1 percent.

Generali tip

Seeing that it might be difficult for you as a private investor to know which stocks will perform better in the long term, a more promising approach is to buy a package of shares from the start – one that is widely spread across different sectors and countries.

Each different share reduces the overall risk. It makes sense to invest in at least 12 – but better still 20 to 30 – different stocks from different sectors and countries. However, if you only invest in equities, the general risk of a stock market collapse still remains. Hence, in order to significantly reduce your overall risk further still, you also need to invest in asset classes other than equities, such as bonds and real estate. In other words: you have to diversify.

It makes no sense to buy one each of various individual securities as the transaction charges and custody fees would be much too high. This is why genuine diversification for small to medium-sized investments is practically only possible through investment funds.

Your risk profile

Your risk profile is a combination of your risk tolerance and risk capacity.

• On the one hand, it refers to your willingness to take risks – which is an emotional factor. Some people like to take risks, others shy away from them in general, not only when it comes to investing money. What is more, risk tolerance fluctuates with the stock market – if prices have risen steeply, investors are more willing to take risks. They then tend to become risk averse after a drop in prices.
• Then there is your risk capacity, which is a more objective value. It depends on the assets you have available to invest, your experience in financial investing and, especially, your investment horizon – the period of time the funds can remain invested.

Generali tip

Do not overestimate your willingness or capacity to take risks. If you have not been interested in investing money in the past and have always skipped the financial pages in a newspaper, chances are that you will overreact to price fluctuations and sell in a panic at the wrong moment. And if you have to sell your assets at the adverse moment because of financial pressures, you will make a loss.
 

The key element: your investment horizon

The longer your investment horizon, i.e. the period over which you are willing and able to invest your assets, the more risk you can afford to take. And, thus, the better your chances of generating returns. This is because shares may cause heavy losses in the short term, but are less likely to do so in the longer term. While you should expect losses of one third for an investment horizon of one year (with a 60 percent chance of making a profit), you can expect very few losses over a period of ten years, coupled with profits of up to 20 percent (see chart).
 

The longer the investment horizon, the lower the risk

The data shows a reduction in risk over the years. In the first year, there is the chance to make a profit of around 60%, but equally to make a loss of around 33%. After ten years, potential profits will reduce to around 20% and the risk of loss to around 2%. With an investment horizon of 25 years, you no longer need to worry about losses, but can expect a return of between 4–12%.
 

The right investment mix

The first thing you should do is establish how much of your assets you are not going to need for a long time – i.e. for at least the next ten years. That is, not even for major purchases such as home improvements, university, training or a trip around the world. You should also always factor in a safety buffer. This is to ensure that you will always have sufficient liquidity , i.e. money in your salary or savings account, that you can access quickly in an emergency. This emergency buffer should be at least three times your monthly salary.

You can then invest the rest of your assets in bonds, possibly supplemented with some real estate or commodity investments. When doing so, it is again important to diversify your investments.

Determining your investment mix in more detail

Good to know

In addition to the uncertainties involved in determining one's own risk profile, it may also change over time. The willingness to take risks tends to decline with increasing age, as does the capacity to take risks. Changes in personal circumstances such as marriage, children, divorce and retirement also affect risk capacity. And, finally, gains and losses made on the stock market can also alter your risk capacity.

We would be happy to discuss your personal needs and work with you to find the right solution for you at any time.