Risk vs. reward is a central tenant of investing. The more risk you’re willing to assume with your investments, the higher the potential return. Conversely, the less risk you’re willing to assume, the lower the potential return.
You may be familiar with what are generally considered to be higher-risk investments — these typically include emerging market stocks, venture capital, hedge funds, and high-yield bonds, to name a few. But what are some of the most common low-risk investments you can choose from?
Here are six low-risk investments if your main goal is safety and capital preservation instead of maximizing return.
1. Money Market Account
Perhaps the most common low-risk investment, money market accounts are similar to old-fashioned bank savings accounts but with one big difference: You can spend money directly from the account by using a debit card or writing a check. Money market accounts allow a certain number of these transactions every month.
The safety of money market accounts comes from FDIC insurance. The Federal Deposit Insurance Corporation insures up to $250,000 in money market deposits against loss (this insurance is per investor and per institution). Most online and brick-and-mortar banks and other financial institutions offer money market accounts so shop around for the best interest rate.
2. Certificate of Deposit (CD)
With a CD, you agree to deposit a sum of money with a financial institution for a certain period of time, such as six months or one year, in exchange for a fixed interest rate. The more money you deposit and the longer the term you choose, the higher the interest rate you’ll usually earn.
CDs typically offer higher rates than money market accounts but at the cost of less liquidity. You will typically have to pay an early withdrawal penalty if you want to access your money before the end of your term. Like money market accounts, most CDs are FDIC-insured.
3. U.S. Treasuries
Essentially loans made to the federal government, U.S treasuries come in the form of Treasury bills, notes and bonds. The main difference between them is the term: Treasury bills are repaid in less than one year, while notes are repaid in two, three, five, seven or 10 years. Treasury bonds are the longest term — they are repaid in 20 or 30 years.
U.S. treasuries are backed by “the full faith and credit of the U.S. government.” In other words, unless the federal government collapses or goes bankrupt, your principal is safe. There may also be tax advantages associated with these investments.
4. Corporate Bonds
Like Treasury bonds, corporate bonds are loans, except they are made to corporations. Corporate bonds usually carry a little bit more risk than money market accounts, CDs and U.S. Treasuries, but they’re still generally considered low risk when purchased from stable, well-established companies.
You will purchase a corporate bond from a specific company for a certain term in exchange for a fixed interest rate. At the end of the term, your principal will be repaid to you unless the bond issuer defaults. Corporate bonds are rated by rating agencies such as Moody’s and Standard & Poor’s to give you an indication of the risk of default.
An Aaa (Moody’s) or AAA (S&P) rated bond is the lowest risk corporate bond you can buy. At the other end of the spectrum, a Caa/Ca/C (Moody’s) or CCC/CC/C (S&P) bond is the highest risk corporate bond you can buy — stay away from these if you’re looking for a low-risk investment.
5. Preferred Stocks
These are ownership shares in companies that pay dividends to shareholders, usually on a quarterly basis. Unlike dividends paid on common stock, preferred stock dividends are usually paid out regardless of whether the stock’s value has risen or fallen. While issuers of preferred stock can choose not to pay dividends, they try to avoid this if at all possible because it usually indicates severe financial stress by the business.
6. Fixed Annuity
This is a contract with an insurance company that pays recurring income over a period of time in exchange for an initial deposit. There are lots of different types of annuities, with different structures and features, but one of the simplest is a fixed annuity. Here, you will receive a fixed stream of income that’s usually paid monthly for a certain time period, including for the rest of your life if you choose.
The main risk of annuities is the potential insolvency of the insurer, so it’s important to research insurance companies before buying this investment. There’s also the risk that the rate of inflation will exceed the annuity’s guaranteed rate, which would erode your purchasing power.
Please give us a call if you have more questions about low-risk investments and their role in your overall financial plan.