There are endless possibilities when it comes to low risk investing. What are the best low-risk investments? Are low risk investments what you want to use to spread your financial footprint? Let’s take a look.
Let’s look at risk and what that means when it comes to investments.
What is the risk?
The risk isn’t a well-defined word when it comes to investments. It’s not necessarily quantifiable, but it does mean at least something to everyone who decides to invest.
The risk is a likelihood of losing money on an investment, the higher the risk the more likely of money being lost. Low risk is less likely to lose money.
The best way to think of risk is the possibility or probability of an asset experiencing a permanent loss of value or below-expectation performance. If an investor buys an asset expecting a 10% return, the likelihood that the return will be below 10% is the risk of that investment.
Types of Risks
Now that we know what risk is we can look at the different types of risks associated with investments.
- Market Risk: The risk that an investment can lose its value in the market (applies primarily to equities and secondarily to fixed-income investments)
- Interest Rate Risk: The risk that an investment will lose value due to a change in interest rates (applies to fixed-income investments)
- Reinvestment Risk: The risk that an investment will be reinvested at a lower rate of interest when it matures (applies to fixed-income investments)
- Political Risk: The risk that a foreign investment will lose value because of political action in that country (holdings located in developing countries are particularly susceptible to this)
- Legislative Risk: The risk that an investment will lose value or other advantages that it offers because of new legislation (all investments are subject to this risk)
- Liquidity Risk: The risk that an investment will not be available for liquidation when it is needed (applies to fixed-income investments and real estate and other property that may not be able to be quickly sold at an equitable price)
- Purchasing Power Risk: The risk that an investment will lose its purchasing power due to inflation (applies to fixed-income investments)
- Tax Risk: The risk that an investment will lose its value or return on capital because of taxation (most investments are subject to this risk)
Low-risk investments or no risk investments can offer returns, but no risk offers the least return.
A no-risk investment would be CDs, savings bonds, life insurance, or treasury securities.
Low-risk investments that yield return are fixed and indexed annuities, investment-grade corporate bonds (rated BBB or higher), insured municipal bonds, and uninsured municipal bonds.
Now, preferred stocks are considered moderate risk but can fall into the low-risk category. A preferred stock is a hybrid security that trades like a stock but acts like a bond in many respects. It has a stated dividend rate that is usually around 2% higher than what CDs or treasuries pay and usually trades within a few dollars of the price at which it was issued (typically $25 per share).
The problem with stocks is the stock market can trend down for long periods of time.
There are some fairly high yield, low-risk investments. These are exactly what you should consider investing in to spread your financial portfolio.
Where to “Risk” It
First, real estate investment trusts. They are trusts that invest in mortgages or equity of numerous properties. They pay off dividends to their investors. The yield is typically higher than what investors get from stock dividends. These are particularly good when the stock market is in decline because they don’t go down with the market.
Dividend-paying stocks are a great option for low-risk investments. There are many well-established companies pay dividends on their stocks. It’s higher than what most low-risk investments will pay. They are the definition of low risk, there is still a risk because they aren’t as safe as treasury securities or other very low-risk investments, but they do have the potential for capital gains.
This gives dividend-paying stocks a reasonable combination of growth and income. In addition, a high dividend will enable you to ride out a prolonged decline in the stock market, since you might continue to receive income on your stock even if the underlying stock price fluctuates. Dividend-paying stocks often do better than growth stocks in bear markets, since investors tend to shift attention from growth to income. You could also purchase an index fund comprised of numerous dividend-paying stocks. Even if you’re mostly interested in preserving your investment capital in retirement, having part of your portfolio invested in dividend-paying stocks will provide you with ongoing income and capital appreciation, which could help you deal with inflation.
P2P or peer-to-peer lending started in 2005. It is online and it matches borrowers and investors in loans that are symbiotic. It’s basically borrowing without a bank as the middleman. The two largest P2P lending platforms are Lending Club and Prosper. Many P2P investments pay out a higher interest rate than you are likely to get on your stock market investments. However, the risk (and reward) can vary considerably based on whom you lend money to.
Another good one is treasury inflation-protected securities.
Treasury inflation-protected securities, better known as TIPS, are another form of U.S. Treasury debt. What separates them from other Treasury securities is that they pay the interest and additional principal to compensate for inflation.
TIPS come in denominations of as little as $100, and in terms of five, 10 and 30 years. The annual inflation adjustment is based on changes in the consumer price index. The percentage change in the value of the security is added to the principal value, rather than being paid out like interest. When the TIPS mature, you are paid the higher value based on the CPI. However, the value of your TIPS could also drop if there is deflation.
Of course, the Federal Reserve will consistently drive inflation.
There are also high-risk investments that people could consider, but if you can’t afford to lose it, don’t risk it.
Low-risk investments are vital to growing a portfolio.