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If you’re thinking about building an investment portfolio, you may be a little concerned about risk. While all investments carry some type of risk, there are some investments that offer lower levels of risk. So, here we’ll delve into those low-risk investments to help you determine which is the best option for you.
What Is Risk?
Investment risk is the probability or uncertainty of loss. Every type of investment is exposed to a degree of investment risk. There are actually several types of risk that can affect your investments.
- Market Risk: This is the risk of investments losing value due to economic events affecting the entire market.
- Liquidity Risk: This refers to the risks of not being able to sell the investment at a fair price. If the liquidity in the market drops, you may need to sell your investment at a lower price and lose value.
- Credit Risk: This applies to a risk of default by the company. If the company faces financial difficulties it may be unable to pay interest to investors and default on its obligations.
- Inflation Risk: This is the risk of a loss of purchasing power due to the return on investment being less than inflation. Inflation will eat away at the returns, lowering the purchasing power of your money.
What Makes an Investment Safe?
Investments are typically termed “safe” when they offer little or no risk of loss. Risk is a large part of investment strategy and many people are risk-averse. This means that they are prepared to earn a lower return in exchange for little risk of losing their initial capital.
There are certain characteristics that make investments safe. The most obvious is that the investment bears a low risk. This means that the returns are typically low, but usually assured.
Safe investments are also typically determined by the timespan of the investment. So, if you’re prepared to hold an investment for longer, it usually becomes a safe investment.
Finally, safe investments usually keep your principal capital intact. There is negligible chances of losing your principal in a safe investment.
Why You Might Want Safe Investments as a Part of Your Portfolio
Investing often requires continual input. Your portfolio is likely to change over time and there will be times when you are prepared to take on more risk. Even if you’re using your investments as a pension fund for well into the future, there are still some compelling reasons to include some safe investments in your portfolio.
The first reason to consider some safe investments is to provide an emergency fund. It’s a good idea to have three to six months of living expenses in an easily accessible investment. This will provide a buffer should any unforeseen events, such as illness or job loss impact your day to day finances.
You should also consider safe investments as you near your financial goal. Whether you’re planning your retirement, a college education, or buying a home, as you get to within a few years of needing the funds, you may want to include more safe investments. Ideally, you should use the profits from your risky investments and increase the money you allocate to safe investments.
The Investments With the Least Risk
Now we’ve established the importance of safe investments and their inclusion in your portfolio, we’ll explore the investments with the least risk.
1. Savings Accounts and Money Market Accounts
Savings accounts and money market accounts are considered to be the safest possible investments. As a consequence, they are also the type of investment that generates the lowest possible returns.
These types of investments have minimal market exposure, so they’re less affected by any fluctuations in the stock market or other economic events.
Unfortunately, you can’t expect to use savings accounts or money market accounts to fund a large purchase. The current interest rate offered on these types of products is typically less than one percent.
This is below the current rate of inflation. So, if you have savings accounts as your sole investment, over time you’ll actually lose purchasing power.
However, these types of investments can be a good idea to hold your emergency fund. You can have the funds readily available should your circumstances change, yet earn a little interest.
CDs or Certificate of Deposits are low-risk savings tools that keep your money invested relatively safely while allowing you to earn interest. Like a savings account, CDs are low risk as they are FDIC insured up to a value of $250,000. Generally, you can grow your savings at a faster rate in a CD compared to a standard savings account.
You will deposit your money for a fixed period and the bank will pay a fixed interest rate that is typically higher than saving account rates. When the CD matures and the term is up, you will get back your principal investment plus the accrued interest.
If you access your funds before the end of the term, an early withdrawal penalty will be imposed on your funds (although there are some “no penalty” CDs). This significantly reduces your return on investment. So, before you open a CD, ensure that you have a comfortable level of savings in an account that is easily accessible so you won’t have to take money out of the CD before it matures.
Generally, the longer the term on a CD, the higher the rate offered. Additionally, longer terms do not always require a larger minimum balance. You can also compound the interest on your CD, so it is added to the principal periodically. This will allow you to earn interest on the additional sum, increasing your returns further.
The attractive thing about CDs is that you can build a CD ladder. This involves buying multiple CDs with different terms. This provides you with better liquidity and access to your funds, if needed, by access just one of the CDs rather than having all of your money in one CD.
The principle is quite simple. You divide your initial investment and open a CD with each portion to mature each year. So, if you had $20,000 to invest, you could invest $4,000 each in one year, two year, three year, four year and five year CDs. As each one matures, you can invest the funds into a new CD at the current interest rate.
Bonds are loans that are taken out by companies. Rather than going to a bank, companies obtain money from investors purchasing its bonds. The company pays an annual interest rate, which is a percentage of the bond’s face value.
The interest on bonds is paid at predetermined intervals that are usually semi annually or annually. On the maturity date, the principal sum is returned and the loan is ended.
Effectively, this makes a bond a type of IOU between the company and investor. Bonds can significantly vary based on its specific terms. Each bond is different, so you need to take care to understand the terms before you invest.
Bonds can vary on term. Short term bonds are typically one to three years, while medium term bonds are approximately 10 years. It is also possible to get long term bonds of up to 30 years.
It is also possible to have secured or unsecured bonds. Secured bonds pledge assets if the company fails to repay its obligations. If the issuer defaults, the assets are transferred to the investors.
Bonds are typically relatively safe, but there are potential risks including a risk of default, which makes them a greater risk than a basic savings account or CD. For this reason, you can expect to earn a higher rate.
4. ETFs and Mutual Funds
If you’re prepared for a little more risk, you can obtain better returns with ETFs and mutual funds. These products provide partial ownership of portfolios with bonds, stocks, and other securities. The portfolio is divided among the participants.
A portfolio manager looks after mutual funds, making the decisions to buy and sell assets to accomplish investment goals.
ETFs or Exchange Traded Funds offer a similar type of investment opportunity. However, they are bought and sold on the stock exchange rather than through a brokerage. Unlike mutual funds, ETFs are not actively managed, which lowers the fees for the investors, but it can provide strategic opportunities across different markets, sectors and industries. ETFs can also trade out poorly performing stocks to minimize risk.
Mutual Funds and ETFs offer investors the potential for solid returns while exposing themselves to lower risk as compared to owning individual stocks. These investments are ideal for long-term investors. There is a great degree of risk for short-term fluctuations and decreases in value, but the risk for long-term investors is significantly smaller.
5. Dividend Stocks
If you want to invest in the stock market, dividend stocks are usually from well-established companies that have a track record of distributing earnings back to shareholders. Many investment experts consider dividend stocks a wise option. They are generally a safer option compared to growth stocks based on the proven track record of the company, but this doesn’t mean that they are boring. There are dividend stocks for companies across a variety of industries.
Dividends represent a percentage of the businesses profits that are paid to its shareholders. This creates a reliable investment as many of the largest and most established US companies offer safe, growing dividend payments.
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You can also use your dividend stocks to generate an income stream. So, you can enjoy capital gains and an income stream from the dividend payments. Of course, you can also use your dividends to reinvest, further growing your investment portfolio.
It’s important to understand that although dividend stocks from blue-chip companies are generally lower risk than growth stocks, any stock investment carries risk of loss.
6. Fixed Annuities
Fixed annuities are basically insurance contracts offering investors an income that is paid at regular intervals until the term has ended, or in some cases the investor’s death.
Financial institutions or insurance companies offer these types of products for a lump sum payment or regular payment. The funds you invest will earn a fixed return throughout the period of annuity. During the annuity phase, the balance is invested, so the fund continues to grow.
There are two major types of annuities; life and term certain annuities. Life annuities pay an amount periodically until the death of the investor. If you choose a straight life annuity it will pay until your death. You cannot leave the investment to a beneficiary. If there is any money left after your death, the company keeps it. You can also opt for a joint life annuity. This allows the spouse to act as a beneficiary, so the surviving spouse can continue to get payments until his or her death.
Term certain annuities pay a predetermined amount each month or other specified period until the product expires. The term is set and at this point, no more payments are issued. If you die before the end of the term, the company keeps the remaining funds.
This makes fixed annuities a powerful vehicle for guaranteeing a regular income stream while saving for a specific financial goal. They can be used for savings or tax deferral. However, the cost of the insurance features may eat into your return on the initial investment. The contracts can be complicated, so it is important that you understand the terms fully before making an investment.
7. Real Estate
Real estate is generally considered to be a safe alternative investment option if you choose the right vehicle. Properties can generate a passive income and provide a long term investment if the value increases. Investing in real estate can be a solid option to build wealth.
Unfortunately, the high initial cost tends to be a barrier to entry for investing in real estate. If you don’t have hundreds of thousands of dollars to purchase an apartment or other property, you may think that real estate investment is out of your reach.
However, in recent years, crowdfunding has allowed smaller investors to access the real estate market. For example, Fundrise is a pioneer in online crowdfunding for real estate. This platform has been operating since 2010 and has had some of the earliest successes in this niche.
Fundrise allows everyday investors to profit from real estate deals with just a few hundred dollars. You can choose to invest in a starter portfolio with low minimums or a core portfolio plan. Your funds will be invested in eFunds and eREITs that consist of private real estate assets across the US. Read our Fundrise Review for more details.
Of course, there are no guarantees for results and it is possible that you’ll lose money, but ideally you’ll get quarterly dividends and asset value appreciation. You’ll need to take a long-term investment approach, but this can be a solid way to build your portfolio with relatively low risk.
Finally, if you’re looking for low-risk investments, you may wish to consider investing in farmland. We all need to eat and there will always be a need for farms, so you can profit from investing in farmland across the US with very low correlation to the stock market. As with real estate, there is typically a high barrier to entry, but there are platforms that can allow investors to get into this potentially profitable niche without some of the normal barriers.
FarmTogether is an online marketplace facilitating farmland investing. It offers accredited investors access to quality farmland investments with a single platform where you can browse investments and review due diligence materials securely online. This makes it easy to invest without needing to spend hours performing your own due diligence. You can invest as little as $10,000 and you’ll receive returns on price appreciation at the end of the period. You may also receive lease payouts quarterly or annually directly into your bank account.
AcreTrader is another platform that allows accredited investors direct access to farmland. The company reviews parcels of farmland and establishes real estate contracts with landowners for appropriate properties. Your purchase is effectively a share in this farm. Each share is equivalent to 1/10 of an acre. AcreTrader handles all aspects of the property management and entity administration. The team works with the farmers who pay cash rent. So, you can expect a gross yield of 3% to 5% and cash distributions every December. At the end of the term, the farmland is sold and the net proceeds are distributed.
Mitigating Risk Without Sacrificing Potential Returns
Now we’ve explored the investments that carry the least amount of risk, you need to gain an understanding of how to mitigate the remaining risks while balancing out the best possible returns.
The key to this is balance. The ideal scenario is to have a balanced portfolio with different types of investments. As we’ve previously discussed, the safer investments tend to attract the lowest returns. If you want to grow your investment fund, you need to ensure that you have a mixture of investments. So, while you may have a preference for CDs or Bonds, it’s a good idea to incorporate other types of safe investments.
This balance is different for individual investors, but it is possible to maximize your returns without taking on further risk. For example, Fundrise and other platforms allow you to benefit from a portfolio of real estate or farmland investments without needing to perform your own due diligence.
A good starting point is to have your emergency fund in a savings account or money market account and then look at longer-term investments. You can create a CD ladder and then look at long term real estate or farmland investments. This allows you to create income streams while building your investment fund, with the reassurance that you have liquid net worth should you find yourself in an unexpected financial situation.