Main Types and Why They Are Low Risk

0
  • The safest investments hold their value, are easily convertible into cash, and are non-volatile.
  • Low-risk investments include CDs, US Treasuries, money market funds, AAA-rated corporate bonds, blue chip stocks, and fixed income.
  • Safe investments tend to have lower returns and their value can erode over time.
  • Visit Insider’s Investing Reference Library for more stories.

When it comes to investing, nothing is 100% certain. For this reason, as opposed to saving, it’s called investing – which is essentially parking your money in an account so that it retains its value.

Investing means investing money in something – a type of financial asset – in the hope of generating a return. Where there is a chance of a profit, there is always a chance of a loss. Risk and return are two sides of the same investment coin.

This means that not all investments are made in the same way in terms of risk. Some investments come with exceptionally low chances of losing your money.

There is no single definition or magic number to define “low risk”, but low risk investments share certain characteristics. They are usually non-volatile – not large fluctuations in price – and they tend to be liquid – meaning they can be easily sold and converted into cash.

Here are seven investments that can be considered safe: that is, they will almost always give you back what you invested. Plus also a certain return.

Payment slips (CDs)

What they are: CDs are offered by banks or

Credit unions
; They are technically a kind of temporary deposit account. They offer a fixed interest rate in return for keeping your money in the account for a period of time – usually six months to five years. Usually, the longer the term, the higher the annual percentage return (APY).

Why they are safe: Federally insured banks rarely go out of business. Even if it did, CDs as banking products are covered by FDIC insurance, up to $ 250,000 per account holder.

US Treasuries

What they are: Issued by the Dept. of the Treasury, US Treasuries are like a loan that you give to the US government: you buy the bond (or note or bill, as the shorter-term loans are called) and the government promises to pay you back with interest later return. For the past 10 years, annual interest rates on 10-year Treasuries, a benchmark for other loans, have ranged from 0.5% to 3.7% – not the highest yield, but definitely the safest (see below).

Why they are safe: Treasury bonds are backed by the “full faith and credit” of the US government. In its 245-year history, this administration has never defaulted on any debt, which is the closest thing US Treasuries to a risk-free investment. In fact, they often serve as a safety benchmark for other investments.

Money market capital

What they are: Money market funds are a type of mutual fund that invests in short-term debt securities and distributes income in the form of dividends. A typical annual return is between 1% and 2%.

Why they are safe: The short-term debt securities that money market funds hold are typically very low-risk in their own right, like CDs and US Treasuries. They are very liquid and come from solid issuers.

AAA rated corporate bonds

What they are: Corporate bonds are debt instruments that companies use to raise money. Investors buy the bond, essentially borrow money to the issuing company, and then receive regular interest payments. When the bond matures, the company pays back the principal amount. Corporate bonds receive letter grades from independent rating agencies; These ratings reflect the financial health and credit history of the issuing company.

Why they are safe: The AAA rating is the highest grade a company and its debt can receive. Companies rated AAA by rating agencies have an extremely high ability to meet their financial obligations – so they are unlikely to default on interest payments on the bond or not pay back the principal. AAA-rated corporate bonds are only marginally riskier than US Treasuries.

Blue chip stocks

What they are: Blue chips are stocks of large, established, and well-resourced corporate giants like Apple, Bank of America, Coca-Cola, Johnson & Johnson, Starbucks, and Visa. They are considered to be the stocks with the lowest risk.

Why they are safe: As stocks, blue chips rank higher in the risk spectrum than bonds, but not by much. These companies have “made it” – they have a long history of success and are often leaders in their field. They pay dividends steadily and their shares keep their value; both tend to move gently but steadily upwards. Of course, there are no guarantees – there have been blue chips that have crashed and burned in the past – but the worst-case scenario is more likely that a blue chip will stagnate rather than lose value.

ETFs with bond or blue chip portfolios

What they are: Exchange traded funds are listed securities that contain a basket of similar assets, often used to track an index of a particular type of asset. There is an ETF for almost every asset in the investment universe, even for low-risk ones. like Treasuries, AAA corporate bonds, and blue chip stocks.

Why they are safe: Diversification naturally reduces risk: it’s the old principle of security in numbers. ETFs that buy a portfolio of other low-risk assets, such as bonds, are particularly low-risk. Also economical: Buying just a few stocks in an ETF gives you exposure to dozens of bonds or stocks.

Fixed income annuities

What they are: Annuities are an insurance product, technically a contract with an insurer. You now deposit an amount with an insurance company, and they later pay you back your principal and interest in a series of payments – for a period of time or even as long as you live. There are different types of annuities, but fixed-rate annuities – which pay the same amount of fixed interest – are among the lowest risk.

Why they are safe: Dierdre Woodruff, senior vice president and secretary at Canvas Annuity, finds that you are guaranteed to get your money back at a predictable rate. It’s part of your agreement with the insurance company. You are required to make these payments at the established rate. “As long as the policyholder leaves his money in the contract for the entire term, he can calculate exactly how his return will be at the end of the term,” says Woodruff.

Of course, there is always a risk that the insurance company will fail (and no, there is no FDIC insurance to cover your funds).

Disadvantages of safe investments

Playing it safe can also have disadvantages. Here are some disadvantages of low risk investments.

Low returns

Low risk investments protect you down but often don’t offer much up. And the safer you are, the less you pay. Citing the Stocks, Bonds, Bills and Inflation (SBBI) Yearbook, Robert R. Johnson, Professor of Finance at Creighton University’s Heider College of Business, notes that Treasury Bills were only 3.3% between 1926 and 2019. brought in per year. In contrast, large-cap stocks returned 10.2%.

And with safe investments you lose something: the chance of higher returns – from another investment.

Inflation risk

Another disadvantage of low risk investments, especially those with fixed interest rates, is the risk of inflation – the risk that rising prices will affect the capital or the return on your investment. That’s one reason why longer-term CDs and bonds pay higher interest rates than shorter ones – the increased risk of inflation.

That is why time is important. When an investor’s time horizon is short, low risk investments with low returns can work. But in the long run, low risk investments that are below inflation will lose their value.

Illiquidity

Even though

liquidity
is part of low risk investments, many of which lock your money. CDs often charge fees if you want to cash out before the term expires. Annuities can come with heavy penalties if you withdraw your funds early, especially after payments have started. Rosen suggests that this illiquidity ranks her a bit higher on the risk spectrum.

The financial souvenir

Every investment has some Risk. But when you invest in the low risk assets mentioned above, you will almost always get back what you invested – and usually more.

While any portfolio can take advantage of some of the security it offers, they are best suited for very conservative investors who want short-term access to their money.

Note, however, that a low risk usually also means a low return. In the long run, they can even cost money if they don’t keep up with inflation.

Investors with a longer investment horizon are probably better off accepting some Risk of loss to hedge against inflation risks.

Related coverage for investments:

Bonds vs. CDs: The Key Differences, and How to Decide Which Income Generating Option is Better for You

What is liquidity? It’s that easy to sell an asset for cash – when and why it matters to your finances

What is the money market? A financial exchange where companies can trade loans and investors can earn interest on their savings

What are Junk Bonds? A risky yet profitable investment that can be worthwhile if you are willing to take the risk

What is a large cap stock? It represents a company with more than $ 10 billion – and often low-risk, stable returns for investors

Share.

Leave A Reply