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When you’re constructing an investment portfolio, diversifying is the much-bellied mantra for success, and that includes the level of risk of your investments.
Relatively low-risk investments may not have the alluring high-payoff potential of some higher-risk investments, but most financial professionals say that having a stable of low-risk investments — such as money market accounts, certificates of deposit (CDs) and high-yield savings accounts — is important.
These options aren’t without any risk, but in general, they keep your money relatively safe and provide some earned income. Here’s our guide on what to know about low-risk investment options for your portfolio.
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What are low-risk investments?
Low-risk investments allow you to earn some sort of interest or gain on your funds. The earnings aren’t unlikely to be sky-high, such as when a particular stock pays off big, but the tradeoff is that there’s little risk to your initial investment.
For example, if you have a hunch about a company and invest aggressively in their stock, you could be right and make a bundle. On the other hand, your hunch may not pay off and you could lose a bundle. If you put the same amount into a low-risk tool, such as a high-yield savings account, you’d experience neither. Instead, your money would earn a bit of interest as it sits safely in the account.
Admittedly, when it comes to money, there aren’t any no-risk options. Even if you hoard cash under your bed or in a safe, there’s not only the potential that it could be stolen or destroyed in a fire, but also, because of inflation, you risk losing purchasing power over time. Still, there are a variety of low-risk investments to consider to play it safe with at least some of your funds.
1. High-yield savings accounts
What it is: A savings account is a widely available tool that holds your money and provides a bit of interest as long as you leave it there. Various savings accounts come with differing interest rates, so you want to find the one that both meets your needs and provides the highest rate available. High-yield savings accounts are often offered through online banks, and they can provide better rates than typical brick-and-mortar bank savings accounts.
Safety level: The safety level is high for savings accounts, as long as you choose a bank that’s insured by the Federal Deposit Insurance Corporation (FDIC) or a credit union insured by the National Credit Union Administration (NCUA). Both protect your money — up to $250,000 — in case the financial institution should fail. You may also want to inquire with each institution as to safety measures they take including things like firewalls and anti-fraud detection measures.
Liquidity level: You can withdraw funds from your savings account anytime, although your bank may have limits regarding how many times you can withdraw per statement cycle. If you go above those limits, you may owe fees and/or your account could be closed.
Returns: The return on your investment in a high-yield savings account depends on the current interest rate. You may get 2% at one point, but then under 1% if the interest-rate environment changes for the worse. It’s not usually significant, but with compound interest, it can add up over time. Note, however, that in some cases there are service fees that can eat away at earnings.
2. Money market accounts
What it is: A money market account is much like a savings account, offering a place to hold money while earning interest. The interest rate for money market accounts is typically higher than that of savings accounts, though they also often require a steeper minimum balance. In many cases, the more you deposit, the higher the interest rate. Note that this is different from a money market fund, which invests in securities and comes with more risk.
Safety level: Money market accounts are also insured by the FDIC and NCUA.
Liquidity level: Like savings accounts, money market accounts allow you to withdraw funds as necessary, though you may be limited to a certain number of withdrawals per statement cycle.
Returns: The more you have to deposit in a money market account, the higher the interest rate you’re likely to earn. As is the case with high-yield savings accounts, the rate is variable and will depend on the interest-rate environment. So you may see a 2% rate for a healthy balance in one year, but that could go down below 1% six months later if overall interest rates decrease.
3. Cash management accounts
What it is: Cash management accounts go by several names, including hybrid checking, hybrid accounts and cash management vehicles. They’re all terms, however, for an account that combines the accessibility of a checking account with the higher interest rates of tools like CDs or high-yield savings accounts. Most of these accounts are offered by online institutions.
Safety level: Cash management accounts are also protected by the FDIC and NCUA. While the interest rate is variable, your initial investment isn’t at risk. Cash management accounts also may have higher FDIC insurance limits than savings accounts, as the money may be kept in multiple partner banks at a time.
Liquidity level: Cash management accounts offer limitless transfers between the checking and savings portion of the account. In fact, those transfers happen instantaneously. However, some cash management accounts require that you transfer money to a third-party account before you can spend those funds, as they may not offer a debit card or checks with which you can spend money directly.
Returns: Many cash management accounts have no monthly maintenance fees and low or no minimum balance requirements. The interest earned is generally more than a typical checking account and depends on the interest rate environment at the time. In a low-interest rate environment, the APY may be well under 1%. In a better interest rate environment, you could see 1% or more.
4. Certificates of deposit (CD)
What it is: Certificates of deposit (CDs) typically offer higher interest rates than savings accounts, money market accounts and cash management accounts. The catch, however, is that in order to get the highest interest rates, you typically must be willing to leave your money in the account untouched for a minimum period of time. Sometimes, this could mean you end up losing money in the end because your cash is stuck in a low-interest CD, even if broad interest rates rise. So, you could be making more money in another investment, yet your money remains in the low-interest account. The interest rate on a CD is locked in for the term of the CD, while the interest rate for savings accounts and many low-risk investments is variable.
Safety level: When issued through accredited lenders, CDs are insured by the FDIC and NCUA.
Liquidity level: The liquidity level for most CDs is low. Unless you leave your money in the CD for the predetermined period of time, you face penalties, which may be significant. There are some no-penalty CDs that allow you to withdraw money at any time, but they may come with lower interest rates than other CDs. That said, they can offer a more favorable rate than a savings account, so it may be worth putting your money in one.
Returns: The highest CD interest rates come from online lenders, and the longer the term of the CD, the higher the interest rate. When interest rates are low, you may find a five-year CD with APYs of up to 1.65% or so, while a one-year CD may only offer 0.50% APY. When the interest rate environment is more favorable, you may find a one-year CD at well above 2% APY.
5. Treasury bills, notes and bonds
What it is: Treasury bills (T-bills), notes (T-notes) and bonds (T-bonds) are issued by the federal government in order to raise money. Their terms vary. T-bills come with terms of one year or less, T-notes with terms of two to 10 years and T-bonds with terms of up to 30 years. T-bills are sold at a discount from their face value and can then be redeemed or reinvested for their face value when their term is up. Notes and bonds pay interest every six months. All are purchased in multiples of $100.
Safety level: Because they’re backed by the federal government, Treasury bills, notes and bonds are some of the safest investments available.
Liquidity level: Treasury bills are the most liquid, as their terms are the shortest, with some even lasting just a few days. Treasury notes are the runner up with terms of two to 10 years, whereas Treasury bonds are designed as longer-term investments, with terms of up to 30 years. You can sell any of them before they mature, though your earnings won’t be as significant.
Returns: The interest rate return varies depending on the term you choose and is determined at auction. Both bonds and notes provide a dependable rate of interest throughout their terms. To give you an idea of where those interest rates may fall, the 10-year government bond rate in 2020 ranged from over 1.8% in January to 0.78% in October.
6. Corporate bonds
What it is: Like government bonds, corporate bonds are issued to raise money, but instead of being issued by the government, they are issued by private companies. An investor buys a bond and agrees to let the company borrow the money for a set amount of time in exchange for interest. When the term is up, the investor gets their original investment back. Terms typically range from one to 30 years. The interest rate typically remains the same for the term of the bond, though floating-rate bonds are also available.
Safety level: Corporate bonds are a bit riskier than the other options we’ve listed above because if a company doesn’t do well or they go bankrupt, they may not be able to pay interest or pay back the bond. To minimize risk, investors should check a company’s credit rating. In general, those with a higher credit rating, and therefore the lowest risk, pay lower interest rates, while the riskier ones with lower credit ratings pay higher interest rates. There’s also an inflation risk to consider when interest rates dip to very low levels.
Liquidity level: Corporate bonds have a relatively high liquidity level, as once you purchase them, you can sell them on the open market.
Returns: Returns depend on the interest rate issued, which varies widely. One other consideration is that unlike government bonds, the interest earned on corporate bonds is taxable. So, in some cases, if the interest rate is low, there is a risk that inflation could surpass the money you earn.
7. Dividend-paying stocks
What it is: Much like their name implies, dividend-paying stocks pay investors who own them a dividend. These dividends most often come in the form of cash payments, but in some cases, they’re paid as additional shares of stock.
Safety level: While there are no guarantees when it comes to stocks, you can look at a company’s history of dividend payouts over the years. For example, many mutual funds and exchange-traded funds (ETFs) only include stocks with dividends that have increased for at least 10 years in a row.
Liquidity level: You can sell dividend-paying stocks at any time. However, you must hold them for a set period of time — usually 121 or 181 days — in order to benefit from reduced capital gains tax rates on the dividends.
Returns: The returns on stocks include both any appreciation in the price of the stock since its purchase as well as the dividends. You should understand that the stock price could go down significantly, which means you can still lose money with dividend-paying stocks. So the returns depend largely on the performance of the stock market as a whole as well as the financial health of the individual companies whose stock you own. You should also understand that companies can cut or even eliminate the dividend payments on their stock.
8. Stable value funds
What it is: Investments in stable value funds are typically offered in 401(k) and other retirement plans, as well as in 529 plans. They invest in fixed-income products that are considered stable, thus their name. The goal of a stable value fund is typically capital preservation.
Safety level: Stable value funds are guaranteed by whoever issues them. You can rest assured that you won’t lose your investment and that the interest rate is locked in from the time you invest.
Liquidity level: Stable value funds aren’t as liquid as some other low-risk investments. In general, they come with terms of six months to a year.
Returns: According to Wealthsimple, the annual return on stable value funds has been 2% to 3%.
9. Fixed annuities
What it is: Fixed annuities are essentially loans to your insurance company that pay off after a set period of time. Similar to a CD, the principal amount invested is protected and a minimum interest rate is set when they’re purchased. From there, your money can grow tax-deferred until the time of payout.
Safety level: The risk level of fixed annuities is low. They’re also good for planning purposes, as you know when you invest how much of a return you can expect down the road at the time of payout.
Liquidity level: Fixed annuities are generally recommended as a long-term investment strategy. You may have to pay additional taxes and fees if you withdraw funds early.
Returns: The returns on fixed annuities depend on the interest rates and rate of inflation. Fees may also lower the return, particularly if you lock in a low interest rate.
When should you consider low-risk investments?
While huge payoffs are great, the fact is the tools that see those payoffs — such as investing in individual stocks — are risky. While some risk may be worthwhile, it’s also good to have a stable base of investments that you can count on.
An ideal portfolio contains investments with varying levels of risk. The proportion of risky investments should be adjusted as your life circumstances change. For example, while you’re young and have years to save for retirement, you may want to take on more risk. The closer you get to retirement and needing the funds, the more conservative you may want to be. A financial advisor can help you weigh the risks and adjust your portfolio accordingly.
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