The 10 key investing concepts (that everyone uses but no one explains)

1. Return

Return is what an investment gains (or loses) over a given period, usually expressed as a percentage. But there are nuances. Cumulative return, which measures everything gained since inception, is not the same as annualized return, which shows the average gain per year. Return should also always be read alongside its reference date and the time frame it covers. A fund that has risen sharply over three months says very little about how it will perform over five years.

2. Risk and volatility

In investing, risk and return go hand in hand: the greater the potential for gains, the greater the likelihood of losses tends to be (although it’s not an exact science). Volatility is the most common way to measure that risk, and it indicates how much the value of an investment fluctuates over time. No level of volatility is inherently better than another; it all depends on what each investor is looking for and how much they’re willing to tolerate.

To make comparisons easier, investment products include a risk indicator in their Key Information Document, rated on a scale of 1 to 7, where 1 is the lowest level of risk and 7 is the highest.

3. Sharpe ratio

If return and risk usually go hand in hand, the logical question is how much return you earn for each unit of risk you take on. That’s what the Sharpe ratio measures. It’s calculated by subtracting the return on a risk-free asset from the return on the investment being measured, then dividing the result by the investment’s risk, defined as its standard deviation, or historical volatility.

The higher the ratio, the better the investment has compensated for the risk taken. Two funds may have earned the same return, but if one did so with much larger swings, its ratio will be lower. The Sharpe ratio is very useful for comparing products within the same category, although it’s calculated using historical data.

4. Drawdown (maximum decline)

Volatility tells you how much an investment fluctuates, but it doesn’t answer the question investors worry about most: How much could I lose at the worst possible moment? That’s where drawdown, or maximum decline, comes in. It measures the drop from an investment’s highest point to its subsequent lowest point.

Drawdown also hides a mathematical trap: losses and gains are not symmetrical. If an investment falls 20%, it needs to rise 25% just to get back to where it started. If it falls 50%, it needs to gain 100%. The deeper the decline, the harder it is to recover, and not in proportion. That’s why many analyses pair it with the recovery period: the time it took the investment to return to its previous peak.

5. Compound interest

The claim that compound interest is the most powerful force in the universe is often attributed to Albert Einstein, although there is no record that he ever said it. Compounding means that the earnings an investment generates are reinvested and, in turn, generate earnings of their own. It’s the snowball effect.

By way of illustration, €10,000 invested at a constant annual return of 5% would grow to roughly €26,500 after 20 years, with no additional contributions. The key is time: the sooner you start and the longer you stay invested, the harder your money works for you.

6. Inflation and real return

Inflation erodes the purchasing power of money. That’s why looking at an investment’s return isn’t enough; you have to subtract the rise in prices to know how much you’ve really earned. If an investment returns 3% in a year when inflation is 2%, the real return is approximately 1%. And money sitting idle in a non-interest-bearing account loses value year after year, even if the balance stays the same.

7. Liquidity

Liquidity is how easily an investment can be converted into cash without losing value in the process. A money market fund or a high-yield savings account is highly liquid; real estate or certain fixed-term products, much less so. That’s why it’s advisable to set aside an emergency fund in readily accessible assets before investing for the long term, so you aren’t forced to sell at a bad time when something unexpected comes up.

8. Duration

The name suggests it refers to a bond’s term, but that’s not quite the case. Duration measures how sensitive the price of a bond, or of a fixed-income portfolio, is to changes in interest rates. It’s expressed in years and takes into account both the bond’s maturity and the coupons paid along the way.

The basic rule is that when interest rates rise, the prices of existing bonds fall, and vice versa. Duration tells you by how much. As a rough approximation, a bond with a duration of 5 years would lose about 5% of its value if rates rose by one percentage point, and would gain a similar amount if they fell. The longer the duration, the greater the potential for price appreciation if rates fall, but also the greater the risk if they rise.

9. TER (ongoing charges)

The TER, or Total Expense Ratio, captures the cost of holding a fund in a single annual percentage. In Spain it’s known as gastos corrientes (ongoing charges), which is how it appears in the fund’s Key Information Document. It combines the management fee, the custody fee, and other operating expenses, but it does not include subscription or redemption fees.

The TER isn’t billed separately; it’s deducted directly from the fund’s net asset value, which makes it easy to overlook. But its impact grows over time. By way of illustration, a €10,000 portfolio earning 5% a year before expenses would grow to about €24,100 over 20 years with a TER of 0.5%, but only to around €19,900 with a TER of 1.5%. That’s compound interest working against you. That said, the cheapest fund isn’t always the best one: what matters is whether the fees you pay are justified by the fund’s performance against its benchmark.

10. Benchmark or benchmark index

A benchmark is a fund’s yardstick: a market index against which a portfolio’s performance is compared to determine whether its management is adding value. A Spanish equity fund, for example, is typically measured against a Spanish stock market index. What matters is not just whether a fund has made or lost money, but how it has performed relative to its benchmark and to similar products, always over sufficiently long periods.

Having this foundation is important, but it’s always wise to work with a professional. Mapfre Gestión Patrimonial has a network of financial experts who can help you build and maintain a strategy tailored to your profile and your goals.