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 investment principles worth knowing include:

1. Compound interest
2. Dollar-cost averaging
3. Risk tolerance
4. Diversification
5. Strategic asset allocation

Let’s look at how you can put these investment principles to work as well as 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 strategy can help you develop a more disciplined approach to investing by addressing 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 now 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. With it, one builds 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:

• Stocks
• Bonds
• Cash equivalents (or money market instruments)
• Alternatives

Today, there are other assets for investors to consider, such as:

• Real estate
• Commodities
• Futures
• 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.

The takeaway

Together, the five key investment principles outlined in this article can help you build more confidence in your own financial roadmap.

When you’re ready for a deeper conversation about your financial plans or if you’re in search of a second opinion on your current strategy with another advisory practice, count on RBFCU Investments Group to help.