What Are Low-Risk Investments?
You want to invest and put your money to work for you, but you’re also concerned about the potential of losing money. If you fall into this category, you may be wondering if there’s such a thing as low-risk investments.
To be clear, no investment is perfectly safe. Rather, investment risk falls along a spectrum. At the risky end are individual stocks, where you can make it big if you pick the next Amazon but also lose your entire investment if a company goes belly-up. Holding cash in a safe, on the other hand, would appear to be on the safest end of the spectrum. Still, even this isn’t entirely risk free because inflation diminishes the purchasing power of that cash stash over time.
As you approach retirement, you may find yourself thinking a lot more about risk, especially during turbulent economic times like we’ve experienced in 2020. You want your savings to grow, but you also want it to be safe.
Ultimately, the answer may not be in one single low-risk investment. Instead, it’s important to spread your portfolio across various assets in a way that aligns with your risk profile. But, if you’re looking for some lower-risk investments, here are some ranked by safety, as well as some ways to think about your exposure to risk as you near retirement.
SAFEST: CASH ALTERNATIVES
Cash: Keeping cash in a checking account, or literally in a safe, is about as low risk as it gets. However, as mentioned, inflation erodes your purchasing power over time. For example, $100 in 2000 is now equivalent to $64 of purchasing power in 2020, accounting for the rate of inflation.
Savings Accounts: Your deposits, up to $250,000, are insured by the FDIC (Federal Deposit Insurance Corporation), an independent agency of the U.S. government. You may also earn some interest, which softens the impact of inflation, though it’s probably less than 1 percent these days.
Money Market Accounts: These combine the convenience of a checking account and typically pay a slightly higher interest rate than a savings account. The catch: You may have to maintain a higher minimum balance.
Certificates of Deposit: These are like loans you make to a bank. You give the bank money and it’ll pay you interest at a higher rate than a savings account. However, you agree not to withdraw a single dollar for the term of the CD (or pay penalties), which could be anywhere from several months to several years worth of interest. At the end of the term, you get your money back on top of the interest you accrued.
Money Market Funds: These are mutual funds that invest in CDs and U.S. Treasury bills. You can earn monthly dividends that are comparable to interest earned in a CD, but you don’t need to lock your money in for months or years. These are very low risk, but since they are technically securities, they are not FDIC insured and they could fall in value.
SOME RISK: FIXED INCOME
Treasury Securities: These are loans to the government and are divided into different categories based on their lengths to maturity (when your principal is returned). Bond prices rise when interest rates drop and fall when interest rates rise. They’re backed by the U.S. government, which makes them some of the safest investments available. Still, there are risks. Treasury bills are traded on a market, which means their value fluctuates from one day to the next. The rate of inflation can also exceed the yield you earn on the bond, effectively eating into your savings.
Treasury Inflation-Protected Securities (TIPS): These are like Treasury bonds, but with a twist. The principal value of TIPS is periodically adjusted to match inflation based on the Consumer Price Index (CPI). Essentially, this prevents inflation from eroding the value of your investment by adjusting your principal as inflation rises or falls. At maturity, you receive the adjusted principal or the original principal, whichever is higher. Interest is paid every six months, which is also affected by CPI. While the bond market does a pretty good job accounting for expected inflation in a bond’s price, TIPS reflect observed inflation. Therefore, TIPS really shine when there’s an unexpected rise in inflation that the market didn’t price in.
Municipal Bonds: These are loans to state and local governments to fund things like libraries, infrastructure, public transit and other projects. In addition to the risks associated with Treasury bonds, there is a slightly higher chance that the issuer fails to make interest payments or repay the principal at maturity — municipal bond defaults, historically, are low. Further, interest from municipal bonds may be exempt from Federal and state taxes if you live in the state where the bond was issued. However, capital gains from selling a municipal bond are still subject to federal and state taxes.
Corporate Bonds: These are loans to individual companies. The income, or yield, from these bonds tends to be higher because the risk of default is also higher — lower-quality, riskier bonds will typically have higher yields than bonds issued by financially strong companies. Like other bonds, they are also impacted by interest rates and inflation.
RISK WITH A DASH OF STABILITY
Mutual Funds and Exchange Traded Funds (ETFs): These are funds that give you access to a portfolio of stocks, bonds and other assets (or combination of them) in a single share. You can buy funds that own a diversified portfolio of U.S. and/or non-U.S. stocks, or you can specify to a sector (technology, industrials) or a style (value stocks, growth stocks, international), or asset class (commodities, fixed income, TIPS). There are thousands of mutual funds and ETFs to suit the needs of investors. However, like stocks they are subject to market risk and can lose value.
Real Estate Investment Trusts (REITs): These are investments in companies that purchase and manage real estate — from skyscrapers to farmland. Companies organized as REITs must pay out at least 90 percent of their net earnings as dividends to shareholders. Therefore, REITs tend to have higher dividend yields. Still, REITs are sensitive to changes in interest rates, and can be just as volatile as stocks.
Blue-Chip Dividend Stocks: These are stocks in long-established companies with strong financials, a reliable business model and they tend to pay dividends. Investors looking for equity exposure and income often turn to blue-chip stocks as they tend to be less risky than stocks in speculative or hyper-growth companies. However, these companies aren’t immune from market volatility, and there’s no guarantee their business models won’t be disrupted, or the companies mismanaged.
STRIKING THE RIGHT MIX
As you can see, there are a lot of safer places to put your money along a spectrum of risk. But how much should you put into risky or safer assets? Unfortunately, that’s a difficult question to answer, as each person has different goals and tolerance for risk. Roughly speaking, you want to lower your risk exposure the closer you get to retirement.
Overall, the goal as you reach retirement is to balance cash you can use today (cash alternatives), low-risk investments for stability and income (fixed income), and a sprinkling of risk for some growth (risk with some stability). While there are broad strategies to make your money last for decades in retirement, a financial advisor can help optimize your savings across the risk spectrum so you can achieve a retirement that isn’t beholden to the whims of the market.
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