When delving into the world of investments, the interplay of risk and reward becomes crucial. The potential for higher rewards is often linked to taking on greater risks, but there are situations where the risk may outweigh the potential gain. In such cases, low-risk investments emerge as a viable option.
The choice of low-risk investments is highly individualized, as it hinges on factors like one’s personality, risk tolerance, investment objectives, and time horizons. Lori Gross, lead investment advisor at Outlook Financial Center, emphasizes that risk is an ever-present aspect of investing, prompting investors to carefully consider how much risk they are willing to bear to achieve their goals.
Now, let’s explore some of the top low-risk investment opportunities that align with more conservative financial goals.
What is a low-risk investment?
A low-risk investment strategy is designed to prioritize capital preservation, aiming to minimize the possibility of losing money. These investments are preferred by risk-averse investors and those with a short investment horizon who seek stability and security over the fluctuations seen in riskier investments like stocks. The appeal of low-risk investments is even higher during periods of high macroeconomic and geopolitical uncertainty, as investors tend to gravitate toward more certain outcomes.
However, it is essential to recognize that low risk does not imply zero risk. Even low-risk investments carry some level of risk, albeit significantly lower than riskier options.
When considering low-risk investments, it’s crucial to assess your time horizon and financial goals. These types of investments are typically best suited for short-term goals, such as those within three to five years. In exchange for the peace of mind that comes with lower risk, investors may be willing to forgo the potential for higher long-term returns.
Ultimately, the key is to strike a balance between low-risk investments and those with higher growth potential. Many investors choose to diversify their portfolios by combining both types of investments, aiming for a smoother and more reliable return stream. By doing so, they can find the right mix that aligns with their risk tolerance and financial objectives.
Who is a low-risk investment best for?
Low-risk investments are ideal for short-term savings, particularly if you anticipate needing your funds in the next three to five years. In such cases, it is wise to avoid exposing your money to too much risk. Short-term investments should prioritize capital preservation, as there may not be enough time to recover from potential near-term losses.
However, for longer-term financial goals, a more aggressive approach with riskier investments may be advantageous. By embracing risk, you open up the possibility of achieving higher returns over time. Long-term investments have the luxury of weathering market fluctuations, allowing the potential for substantial growth.
5 types of low-risk investments
Treasury bills, Treasury notes and TIPs
Treasury bills, Treasury notes, and Treasury Inflation-Protected Securities (TIPS) are government-backed fixed-income investments that offer various durations and rates of return. Treasury bills mature within one month to one year, while Treasury notes have maturities ranging from two to 10 years. On the other hand, Treasury bonds have longer maturities of 20 to 30 years.
One advantage of investing in government-backed securities is their lower risk. The U.S. government is highly unlikely to default on its obligations, providing a sense of security for investors. These fixed-income securities offer predictable returns, making them suitable for structuring an income portfolio.
However, the trade-off for this safety is that government-backed securities typically provide lower returns compared to other investments. The adage “lower risk equals lower return” holds true in this case. In some instances, the rate of return might not keep up with inflation, leading to a potential erosion of purchasing power.
To address this concern, investors may consider Treasury Inflation-Protected Securities (TIPS). TIPS come with a principal adjusted for inflation, which means that if inflation rises, the principal will increase accordingly. This feature protects investors from the risk of inflation eroding their purchasing power.
Pros and cons of Treasury bills, Treasury notes and TIPs
| PROS | CONS |
|---|---|
| Liquidity | Low return |
| Regular income | It may not keep up with inflation |
| Government-backed |
Fixed annuities
A fixed annuity provides a contractual agreement between an individual and an annuity provider. It involves making one or more payments to the provider in exchange for a guaranteed fixed rate of return for a specific period of time. The payments received can either be spread out over time or received as a lump sum during the payout period, depending on the terms outlined in the policy.
One advantage of a fixed annuity is the predictability it offers. The investor knows exactly how much money they will make from the annuity and can maintain that rate for a predetermined period. Another benefit is the tax advantage, as the earnings grow tax-deferred until withdrawals are made. However, it’s important to note that taxes will apply to the withdrawals, and they will be subject to ordinary income rates.
There are two main types of fixed annuities: immediate and deferred. An immediate annuity begins providing payments within the first year after purchase, generally funded by a single lump sum. On the other hand, deferred annuities offer more flexibility, allowing the investor to start receiving income at least one year after the purchase and allowing periodic contributions instead of a lump sum.
Pros and cons of fixed annuities
| PROS | CONS |
|---|---|
| A guaranteed rate of return | Limited upside potential |
| A predictable future income stream | Earnings may not keep up with inflation |
| Withdrawals are taxed |
Money market funds
Money market funds are investment vehicles that primarily focus on short-term debt securities, including Treasury bills and certificates of deposit (CDs). While they offer the potential for higher returns compared to traditional savings accounts, they also come with slightly more risk. However, the risk involved is still considered minimal.
These funds are designed to be a cash alternative for investors. Despite the increased upside, it’s essential to acknowledge that there is a greater chance of losing money compared to holding funds in a savings account.
Due to their investment strategy of sticking to short-term and low-risk securities, money market funds are generally regarded as one of the least risky investment options.
To facilitate ease of use for investors, most money market funds aim to maintain a stable net asset value (NAV) of $1 per share. This allows investors to treat these funds almost like cash. If necessary, you can sell shares of a money market fund like any other type of mutual fund. One attractive aspect of these funds is that they offer CD-like rates without the restrictive lockout periods associated with CDs.
Pros and cons of money market funds
| PROS | CONS |
|---|---|
| Potentially higher interest than a savings account | No guarantees on earnings |
| More liquid than CDs | Rates of return probably won’t outpace inflation |
| Low volatility |
Corporate bonds
Corporate bonds are debt securities issued by corporations. When you invest in a corporate bond, you are essentially lending money to the issuing company. In return, you receive regular interest payments and the promise of getting your initial investment back when the bond reaches maturity, provided the corporation doesn’t default on its debt.
Compared to U.S. government securities, corporate bonds come with higher risks. Corporations are more likely to face financial difficulties, which makes corporate bonds riskier than U.S. Treasuries. In the worst case, a corporation may go bankrupt, leaving bondholders without full repayment.
Corporate bonds are categorized into different tiers based on their risk levels. Investment-grade corporate bonds are considered less risky as the issuing corporations are more likely to honor their debt obligations. However, these bonds tend to offer lower yields compared to riskier options.
On the other hand, non-investment-grade corporate bonds, also known as high-yield or junk bonds, come with higher risk. These bonds are issued by companies in financially challenging situations but offer higher yields as compensation for the increased risk.
Bond rating agencies such as Moody’s, Standard & Poor’s, and Fitch play a crucial role in evaluating and assigning grades to corporate bonds. These grades determine whether a bond is considered investment-grade or non-investment grade.
One challenge of investing directly in corporate bonds is the lack of liquidity. When you buy a corporate bond, your money becomes tied up until the bond matures. While you can sell corporate bonds on the secondary market, the price you get is uncertain and may not be as favorable as expected.
To address the liquidity issue and gain more flexibility, investors can consider bond ETFs (Exchange-Traded Funds). These funds hold a portfolio of dozens or even hundreds of corporate bonds. ETFs function like stocks, allowing investors to trade individual shares of the fund. This approach combines the stability and income of bonds with the ease of trading like stocks.
Pros and cons of corporate bonds
| PROS | CONS |
|---|---|
| Higher potential returns than other low-risk debt securities. | Greater risk of default than U.S. Treasurys |
| Provide regular income | Lower returns than stocks |
Series I savings bonds
Series I savings bonds present an attractive option for low-risk investments, as they address the challenge of keeping up with inflation. These bonds offer a unique combination of a fixed rate of return and an inflation-linked rate, with interest being compounded semiannually. The composite rate for I bonds issued from May 1, 2023, to Oct. 31, 2023, stands at 4.3%, making it an appealing choice for investors.
Moreover, the income earned from Series I bonds is exempt from state and local income taxes, providing an advantage to investors by allowing them to retain more of their earnings.
However, there are a few important stipulations to consider. Firstly, you cannot cash out the bonds for at least one year, unless you reside in an area impacted by a natural disaster. Additionally, if you cash out before five years, you’ll lose the last three months of interest. This implies that these bonds are better suited for long-term investments, with a 30-year maturity period offering the potential for substantial returns.
When it comes to purchasing these bonds, you have the flexibility to buy electronic I bonds in small amounts starting from $25, but there is a cap of $10,000 per person annually. However, you can opt to buy an additional $5,000 in I bonds in paper form if you wish to invest more.
Pros and cons of Series I savings bonds
| PROS | CONS |
|---|---|
| Low risk | Limited liquidity |
| Inflation protection | Early withdrawal penalties |
| Backed by the U.S. government | An individual can’t receive more than $10,000 of electronic I bonds each year |
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