Is there such a thing as a safe investment?


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Stocks are predictably unpredictable. And yet, even the media pundits who are paid to talk us through those roller-coaster twists seem to be surprised when there’s an especially big rise or dip in the market.

It’s no wonder average investors can get a little dizzy at the top and queasy at the bottom — or that they might start thinking about moving their hard-earned money to something safer when things get especially scary.

But is there such a thing as a safe investment?

The short answer is no. Some may be considered safer than others, but no investment is completely free of risk, because there’s more than one kind of risk.

Related: What every new investor should know about risk

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Different types of risk

Investors who choose products and strategies to avoid market volatility may be leaving themselves open to other risks, including:

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Inflation risk

An asset could become less valuable as inflation erodes its purchasing power. If an investment is earning little or nothing (a certificate of deposit or savings account, for example), it won’t buy as much in the future as prices on various goods and services go up.

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Interest rate risk

A change in interest rates could reduce the value of certain investments. These can include bonds and other fixed-rate, “safe” investment vehicles.

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Liquidity risk

Could an asset be sold or converted if the investor needs cash? Collections, jewelry, a home, or a car could take a while to market — and if the owner is forced to sell quickly, the price received could be lower than the asset is worth. Certain investments (certificates of deposit, some annuities) also may have some liquidity risk because they may offer a higher return in exchange for a longer term, and there may be a penalty if the investor cashes out early.

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Tax risk

An investment could lose its value because of the way it’s taxed. For example, different types of bonds may be taxed in different ways.

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Legislative risk

A change in law could lower the value of an investment. For example, if the government imposes new regulations on a business, it could result in higher costs (and lower profits) for the company or affect how it can serve its customers. Or, if taxes go up in the future, savers who put all or most of their money into tax-deferred accounts [IRAs, 401(k)s, etc.] could end up with a hefty tax bill when they retire.

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Global risk

An investment in a foreign stock could lose value because of currency problems, political turmoil and other factors.

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Reinvestment risk

When an investment matures (think CDs and bonds), the investor might not be able to replace it with a similar vehicle that has the same or a higher rate of return.

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Why invest if it’s so risky?

If a person can’t invest without risk, why invest at all? Because every year, goods cost more and more, which can make it difficult to save for a goal, build a nest egg in a basic savings account or by stuffing crumpled bills in a coffee can hidden in the back of the closet. (Not that there’s anything wrong with keeping a little stash of fun money or a savings account for emergency funds.)

There’s a reason the sayings “nothing ventured, nothing gained” and “no risk, no reward” have been around so long.

But besides all those different types of investment risk, there are also different levels of risk, from low to moderate to aggressive or even speculative. And having some knowledge of where various investments fall on that range of risks — as well as the types of risks a particular investment could be exposed to — may help investors find the returns they need while still holding on to some sense of control.

Of course, it also helps to know thyself.

Because netting bigger rewards often means taking on more risk, investors may benefit from understanding the degree of risk they’re comfortable with and capable of enduring.

Are they willing to get on the biggest, baddest thrill ride out there, hanging on with white knuckles through the peaks and plummets? Or would they prefer something that’s slow and steady, that keeps chugging along with no big surprises?

Or maybe they’d be happiest somewhere in the middle, with the potential for a few minor bumps, but not the kind of crazy stuff that could leave them financially and emotionally drained.

Unfortunately, investors aren’t likely to find big signs posted in front of their choices (Warning: You must be this risk tolerant to buy this stock). That’s why some investors research every asset they add their portfolio — or get help from a professional advisor.

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Understanding an investment’s risks

It is possible to get a general feel for where various investments fit on the risk-to-reward scale. For example, certificates of deposit might be on the low end as far as risk, while hedge funds and promissory notes could be on the higher end of the scale.

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Investments known for low risk

Investors who are shopping for something very low in risk and who are willing to accept a lower return might look at CDs, U.S. savings bonds, and U.S. Treasury securities (bills, notes and bonds).

Because interest rates are currently so low, none of these investments offer a big payoff, and they’re vulnerable to inflation and/or liquidity risk. But it’s unlikely an investor would lose all or a big chunk of their money with any of these choices:

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Certificates of deposits (CD)

CDs are similar to a savings account, and they’re FDIC-insured, which means the government will cover the depositor’s principal and interest (up to $250,000) if the bank or savings association the CD is at fails. But unlike other bank accounts, savers must leave their money in the account for a designated period of time — usually from a few months to a few years. The longer the term, the higher the interest rate. And if savers take out the money early, they might have to pay a penalty (although there are some exceptions).

CDs used to be a popular tool for those looking for a safe place to stow their money, when interest rates were in the double digits. But these days, with rates averaging less than 1%, even for a five-year CD, they’ve lost their luster for many who are looking to grow their money — or, at least, keep up with inflation.

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US savings bonds

Investors purchase EE savings bonds (the most common type of savings bond) from the U.S. government for half the face value and accrue interest monthly based on a fixed rate. The interest rate is set for the first 20 years after purchase, and the Treasury guarantees an EE bond will be worth at least its face value when those 20 years have passed. After that, the Treasury resets the interest rate and extends the maturity by 10 more years.

Investors don’t have to hold onto a savings bond for the entire 30 years, but they do have to wait at least a year before redeeming it. And they’ll forfeit three months’ interest if they redeem a bond during the first five years after they purchased it. The current rate for EE bonds is 0.10% annually, so the return may be safe, but it’s also slow.

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US Treasury securities

Treasury securities (bills, notes, and bonds) are sold and backed by the “full faith and credit” of the U.S. government. What does that mean? Treasury securities provide funding for the government in exchange for a fixed interest rate. Because the government has the means to repay its investors (by printing more money or raising taxes), it’s highly unlikely it will default on these obligations, so investors are guaranteed the return of their principal and any interest they have coming, as long as they hold onto the security until its maturity date.

Treasury securities have relatively low interest rates compared to other investment choices, so though they’re considered safe, they aren’t necessarily the best choice for those looking for big gains in their portfolio.

Different types of government securities come with different lengths of maturity, and their interest rates are based on those term lengths. Treasury bonds have a higher interest rate in exchange for a longer term (30 years), but that lengthy term can be a drawback.

Once an investor buys a Treasury security, the terms won’t change — even if a better interest rate comes along soon after the purchase. Investors simply have to accept that newer bonds may pay higher rates. And if they decide to sell a bond before the maturity date while bonds with higher rates are available, it could be tough to find a buyer without losing some money on the investment.

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Money market funds

Money market funds are fixed income mutual funds that invest in short-term low-risk debt securities and cash equivalents. Money market funds must comply with regulatory requirements regarding the quality, maturity, liquidity and diversification of their investments, which can make them appealing to investors who are looking for something safe and steady that pays dividends.

But because of the safety and short-term nature of the investments within these funds, returns are generally lower than those of stock and bond mutual funds that are more exposed to risk. Which means they may not keep pace with inflation.

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Investments known for low to moderate risk

Investors who are willing to take on more risk — even if it’s just a bit more — may find specific types of bonds and preferred stocks offer the yield they need. Their choices might include:

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Investment-grade corporate bonds

Corporate bonds may not be as safe as CDs or government bonds, but they are generally considered to be a lower risk than stocks. The term “investment grade”  lets investors know a bond is a lower risk based on ratings received by either Standard & Poor’s or Moody’s.

A higher-quality investment-grade bond — rated AAA, AA+, AA and AA- by Standard & Poor’s — can be expected to perform consistently and pay interest on a regular basis that can be used for income or to reinvest. Bonds rated A+, A and A- also are considered stable, while those rated BBB+, BBB and BB- may carry more risk but are still considered capable of living up to their debt obligations. Like other types of bonds, corporate bonds are susceptible to interest rate risk, and with a longer commitment, there’s typically more exposure to that risk.

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Municipal bonds

Municipal bonds, or munis, have tax advantages that corporate bonds don’t have. Though the interest rate is generally lower than similarly rated corporate bonds, they are exempt from federal taxes, and some also may be exempt from state or local taxes.

Munis also are considered fairly liquid, although there’s always the risk that, based on what’s happening in the market or economy, there won’t be a buyer. And though the default risk is considered low on munis, there is the chance that rising interest rates could cause prices to go down.

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Preferred stocks

Preferred stocks, or preferreds, may be an appealing option for conservative investors looking for a higher yield than CDs or treasuries have to offer. Preferreds are often referred to as a “hybrid” investment, because they trade like stocks but are like bonds in that they provide income.

They generally pay quarterly dividends that can be used as income or reinvested for more potential growth. In a worst-case scenario, if a company can’t pay its preferred dividends for a while, the money owed accumulates as backpay. And when the company resumes payments, preferred shareholders get their accumulated dividends before those who own common stocks.

Preferreds can be sold at any time, but they’re typically used as a long-term investment. Just as with corporate bonds, companies that are more financially stable will receive higher marks from credit ratings agencies, so investors can have some idea of what they’re getting into.

Still, the ins and outs of buying preferred shares can be complicated, so beginners may want to work with a financial professional who is experienced in this type of investment.

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Blue chip stocks

Stocks issued by big companies that have a reputation for performing well in good times and bad are typically known as blue chips. They aren’t immune from big losses, but they tend to handle market drops better than other stocks.

The companies are usually household names — Coca-Cola, Procter & Gamble, Johnson & Johnson — and have a history of dependable growth and paying consistent dividends. Investors who want to do some research can get insight on blue chips by checking out the “Risk Factors” section of a company’s annual 10-K filing.

Companies are required to list their most significant risks, usually in order of importance. Some risks apply to the entire economy, some to that particular industry and a few may be specific to that company.

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Investments known as having a higher risk

We tend to think of risky investments as the type that result in either a jaw-dropping payoff or a soul-crushing loss — and that they aren’t for the faint of heart. But another way to look at it might be in terms of probability: What are the chances the investment will underperform or result in a substantial loss?

Is the potential gain worth passing up on steadier and safer investment returns? Is this an investing decision based on careful research and/or sound advice, or is it a gamble? Traditionally, risk is equated with owning stocks, but there are other investments that also require careful consideration before hopping onboard.

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Cryptocurrency, or crypto, is a digital currency that operates independently of a central bank. Crypto refers to the encryption used to keep the transactions safe.

There are many cryptocurrencies in issue. The most well-known is probably bitcoin, and its price has been unstable since its founding in 2010. So while the crypto market is maturing, and there’s more oversight and regulatory control, it’s still considered an extremely risky investment.

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Hedge funds

Hedge funds pool their investors’ money to buy securities or other types of investments, just like mutual funds. But they aren’t as heavily regulated as mutual funds and have more latitude when it comes to pursuing riskier investments — and they often do. They also may have higher fees than other types of funds.

Hedge fund managers are paid based on their performance, which may make them more willing to go for the bigger payoff. It isn’t a level of risk just anyone can handle: Most hedge fund investors are “accredited,” which means they have the designated level of income or assets to invest.

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Promissory notes

Promissory notes are similar to bonds in that investors loan money to a company and in return, they’re promised a fixed amount of periodic income. But since promissory notes are typically issued when a business can’t get a traditional loan, they’re associated with greater risk, and investors who buy these notes do so with the expectation that they’ll get a greater rate of return. The SEC also warns that promissory notes sold to investors are often scams. Investors can verify the legitimacy of a promissory note by checking the SEC’s EDGAR database or by calling their state securities regulator.

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Real estate securities

Real estate investment trusts (REITs) offer investors an opportunity to earn income through commercial real estate ownership without the hands-on work of buying and running the properties themselves. Investors can use REITs to diversify their portfolio, and some REITs may offer higher dividend yields.

But there are risks — particularly when investing in non-traded REITs, including liquidity risk, high fees and commissions that can lower an investment’s value, and tax implications. Just as with promissory notes, investors can use the SEC’s EDGAR system to review a REIT’s history and other information.

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Protection through diversification

When investors are deciding how much risk they should be taking, there are a few things they may want to consider, including their age, personality and purpose. Investors who can’t handle a lot of risk for any or all of those reasons may wish to lean toward those investments that are typically the safest.

But another way to help protect a portfolio is through diversification: choosing investments from different asset classes, in different sectors and with different risk factors. Think of it as riding the coasters and the kiddie rides.

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Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRAthe SEC, and the CFPB, have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments.
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