Lesson 2 of 5 · 7 min read
Risk, diversification, time horizon and DCA
Four concepts that together form the skeleton of any rational investment decision, whatever instrument you choose.
The risk-return relationship
In general, instruments with higher potential return come with higher risk (volatility, the possibility of loss). There is no guaranteed high return without risk: any offer that promises it is a warning sign (see the lesson on evaluating brokers and the Scam shield page).
Diversification
Diversification means splitting the investment across several different assets (companies, sectors, countries, asset classes), so that the poor performance of one doesn't badly hurt the whole portfolio. A single diversified ETF can give, at a single purchase cost, exposure to hundreds of different companies.
Time horizon
The time horizon, the period during which you won't need that money, decides how much risk and volatility you can afford to tolerate. Money you need in 1 or 2 years shouldn't be exposed to very volatile instruments; money with a horizon of 15 to 20+ years can tolerate big swings along the way, because it has time to “recover”.
DCA: regular investing
DCA (dollar-cost averaging) means investing a fixed sum at regular intervals (for example, monthly), whatever the market level at the time, instead of trying to “guess” the best moment to buy. Over the long term, DCA reduces the psychological and practical impact of volatility: you automatically buy more when prices are low.
Legal note
Strictly educational information, with no recommendation to invest in any particular instrument or at any particular time.
In short
- Higher potential return almost always comes with higher risk.
- Diversification reduces the risk specific to a single asset.
- The time horizon decides how much risk you can afford to tolerate.
- DCA removes the need to “guess” the best moment to buy.