5 Key Investment Principles to Know
Predicting the future in the ever-shifting landscape of financial markets can be daunting. By better understanding — and possibly using — a handful of key investment concepts, you may positively impact your long-term finances.
Briefly, five common principles worth knowing include:
- Compound interest
- Dollar-cost averaging
- Risk tolerance
- Strategic asset allocation
Let’s look at how you can put these investment principles to work — and the impact they can have on your financial well-being.
What is compound interest?
Compound interest occurs when the interest earned on an initial investment is reinvested. You can then earn interest on your interest income. Over time, it can increase the amount of money you have to fund big-picture goals like retirement, education or a home's down payment.
As your initial investment grows, future interest is calculated based on the newer, more significant sum, creating a compounding effect. Over time, this compounding can significantly increase an investment’s value. The earlier you start saving, the more time you can benefit from compound interest.
What is dollar-cost averaging?
Dollar-cost averaging is a strategy that can help protect investors from market volatility. Rather than attempting to time lump-sum investments based on the market conditions, dollar-cost averaging involves regularly investing fixed amounts — regardless of market fluctuations.
This can help you develop a more disciplined approach to investing by eliminating emotional decisions1 surrounding market highs and lows. It may also pave the way for you to take advantage of market downturns by allowing the purchase of more shares when prices are low and fewer shares when prices are high.
Over time, dollar-cost averaging may reduce the average cost per share, potentially lessening the impact of short-term economic shifts.
What is risk tolerance?
Risk tolerance refers to your comfort level when it comes to potential risks in your portfolio. In other words, it can be an essential factor in determining your investment strategy and how comfortable you are with seeing swings in the numbers on statements sent by your financial firm.
There are three main categories of risk tolerance:
- Aggressive: Typical of wealthy, experienced investors with a broad portfolio, this approach involves a willingness to accommodate potentially huge losses in poor markets.
- Moderate: Investors with this level of tolerance are willing to take some losses, but they balance their risky investments with less-risky ones.
- Conservative: People with this level of risk tolerance are more apt to prioritize avoiding losses over making big gains.
Higher-risk investments may offer higher potential returns — and increased instability or the possibility of substantial losses. More conservative investments may yield lower returns but generally provide more stability.
Different individuals have varying capacities to withstand market volatility and potential financial losses. Understanding your risk tolerance is vital for crafting a portfolio that resonates with your comfort level and perhaps even your stage of life or proximity to retirement.
>> Tip: To determine your risk tolerance, discuss your financial goals, time horizon (the time you have for your investments to work for you), financial obligations and emotional tendencies with an RBFCU Investments Group financial advisor. Meet our financial advisors or make an appointment today.
What is diversification?
Diversification can reduce risk by spreading investments across different asset classes, industries, sectors and geographic regions — keeping your investments well balanced.2
Diversification does not eliminate risk, but it can help manage and lessen it. Varied investments respond differently to economic events and market shifts. Diversifying may reduce the impact of a poorly performing investment on an overall portfolio.
The challenge is to strike a balance between diversification and concentration — too much diversification could dilute potential gains, while not enough diversification might expose a portfolio to undue risk.
What is strategic asset allocation?
Strategic asset allocation is a deliberate, long-term approach, building a portfolio by determining the optimal mix of asset classes that match your financial goals, risk tolerance and time horizon.
It’s helpful to understand that an asset class is a group of investments with similar characteristics subject to the same federal rules and regulations.
Historically, the standard asset classes have included:
- Cash equivalents (or money market instruments)
Today, there are other assets for investors to consider, such as:
- Real estate
- Other financial derivatives
Strategic asset allocation balances your risk tolerance alongside potential returns based on historical performance and future expectations across your assets. It also involves regular review and rebalancing to maintain the desired allocation3 as markets fluctuate. For instance, if stocks outperform bonds over time, the portfolio might become stock-heavy, requiring a rebalance to realign with the initial allocation.
Together, the five key investment principles outlined in this article form an investing roadmap.
Regular portfolio reviews with a qualified financial advisor can help an investor like you stay in tune with the principles and changes that may come over time. When you’re ready to have a deeper conversation about guiding your investments as part of a comprehensive plan, you can count on RBFCU Investments Group to help explore solutions and develop a strategy.
This article was last updated in December 2023.
This information is being provided only as a general source of information and is not a solicitation to buy or sell any securities, accounts or strategies mentioned. The information is not intended to be used as the primary basis for investment decisions, nor should it be construed as a recommendation or advice designed to meet the particular needs of an individual investor. Please seek the advice of a financial advisor regarding your particular financial situation.
Investment products are not insured by the FDIC, NCUA or any federal agency, are not deposits or obligations of, or guaranteed by any financial institution, and involve investment risks including possible loss of principal and fluctuation in value.
Ameriprise Financial Services has a partnership with this financial institution to provide financial planning services and solutions to clients. The financial institution is not an investment client of Ameriprise but has a revenue sharing relationship with us that creates a conflict of interest. Details on how we work together can be found on ameriprise.com/sec-disclosure.
Ameriprise Financial is not affiliated with the financial institution.
Ameriprise Financial cannot guarantee future financial results.
Dollar cost averaging, diversification, and asset allocation do not assure a profit or protect against loss.
Alternative investment strategies and structures may involve substantial risks, may be more volatile than traditional investments, and are designed to be low or non-correlated to traditional equity and fixed income markets.
There are risks associated with fixed-income investments, including credit risk, interest rate risk, and prepayment and extension risk. In general, bond prices rise when interest rates fall and vice versa. This effect is usually more pronounced for longer term securities.
Stock investments involve risk, including loss of principal. High-quality stocks may be appropriate for some investment strategies. Ensure that your investment objectives, time horizon and risk tolerance are aligned with investing in stocks, as they can lose value.
RBFCU Investments Group is a financial advisory practice of Ameriprise Financial Services, LLC.
Investment advisory products and services are made available through Ameriprise Financial Services, LLC, a registered investment adviser.
The following sources were last accessed December 2023.
1“How to Navigate Market Volatility.” Ameriprise.com, https://www.ameriprise.com/financial-news-research/insights/navigating-market-volatility.
2,3“6 Key Investment Principles.” Ameriprise.com, https://www.ameriprise.com/financial-goals-priorities/investing/six-keys-to-more-successful-investing.