- What Is Investment Risk?
- The Role of Risk in Investing
- What Level Of Risk Is Right For You?
- 7 Types Of Low-Risk Investments
- Conclusion: Investments With The Least Risk
Many people decide to stay away from investing their money because all types of investing involve risk. That is, there’s a chance that you could lose some of your investment when the market turns sour.
However, investing doesn’t have to mean putting yourself on a financial roller-coaster ride. There are plenty of low-risk investments that offer moderate returns and a relatively low chance of losing money. You may be wondering which investment type typically carries the least risk. So, let’s take a closer look at what investment risk is and 7 types of assets you can invest in with relatively little risk.
What Is Investment Risk?
Risk in investing is a measure of how likely it is that the outcome of your investment could differ from your expected outcome. Typically, when investors talk about risk being high, it means that you could lose a significant amount of your initial investment.
For example, if you were to invest $1,000, you might consider your investing risk to be high if there is a strong chance you could lose $500. On the other hand, if the worst possible outcome (or at least, the worst likely outcome) is that you could lose just $100, your investment would be considered less risky.
The Role of Risk in Investing
The most important thing to know about risk is that it’s everywhere in investing. In fact, risk is the underpinning of investing – you are making money as a reward for taking on financial risk.
However, that doesn’t mean that investing is bad. In fact, you could consider not investing to be risky in its own right, since money sitting in a bank account loses value to inflation over time. By not investing, you’re at risk of losing money to rising inflation rates.
The thing to remember is that not all investments carry the same amount of risk. It’s important to make a conscious decision about how much risk you are willing to take on and to carefully evaluate the potential financial reward you stand to receive in exchange for taking on that risk.
In addition, you can choose to spread your money over multiple investments, each with a different level of risk. That way, some of your investment might be in a high-risk asset while another portion of your investment is in a low-risk asset.
When thinking about risk, it’s important to consider the timeframe over which you’re investing. In the short-term – that is, on the scale of weeks to months – the market can go up and down quite a bit. So, short-term investing can be more risky because there’s a chance that the market will be down at the time you need to sell your investments.
Over the long-term, though – that is, over the course of years to decades – the value of assets like real estate and stocks has historically gone up very reliably. So, investing in the stock of a major company like Apple might be considered somewhat risky if you have an investment horizon of less than a year, but much less risky at all if you are planning to stay invested for 10 years.
Once you set your investment timeframe, you shouldn’t get distracted by risk that is irrelevant to your goals. For example, if you plan to hold Apple’s stock for 10 years, you shouldn’t concern yourself with short-term price fluctuations. Short-term price fluctuations may be “noise” that stresses you out for no reason. For example, in early 2020, Apple’s stock dropped 35% in a few months – by November 2020 it was up over 60% on the year (representing a 120% rally).
This isn’t to say you should ignore short-term risk entirely. Short-term risk may correlate with long-term risk. That said, you shouldn’t stress yourself out with market fluctuations that are irrelevant to your long-term goals. If you have a specific risk threshold, you can create a risk mitigation plan (i.e. cut losses at 10%).
Risk vs. Reward
In financial markets, taking on more risk is typically rewarded with potentially greater returns on your investment. In general, low-risk investments tend to deliver relatively modest returns each year, while high-risk investments like stocks could return 10% or more per year. So, it’s important to think about balancing the level of return you want to see from your investments with the level of risk you’re willing to accept.
What Level Of Risk Is Right For You?
The amount of investing risk that’s right for you depends on a number of factors.
To start, think about your financial goals relative to where you are financially right now. If you’re young and investing for retirement, you may be okay taking on higher risk investments because your time horizon is decades. On the other hand, if you’re investing for your retirement and you’re over 60, you may want to look for low-risk investments since you will need that money in the near future.
Another thing to think about is your stomach for risk. If you invest in a risky stock, will your stomach drop if the stock market crashes? Or can you set up an investment and then not think about it more than once a year? Investing shouldn’t leave you feeling exhausted, so make sure you’re personally comfortable with where you put your money.
7 Types Of Low-Risk Investments
With all that in mind, let’s take a look at 7 of the best investments that carry less risk than most stocks.
One type of investment considered low-risk is bonds. Bonds are debt certificates, like I.O.U. notes, issued by a corporation or government. When you invest in a bond, you’re giving out a loan to the bond issuer. In return, you receive steady interest payments once per quarter or once per year. You also get a promise that you will receive the entire principal you paid for the bond back on a specific date in the future.
The main risk when investing in bonds is that the issuer could go bankrupt. However, if you choose a relatively safe bond, this is unlikely to happen. Corporate bonds are rated on a letter scale, so you can choose ultra-safe AAA-rated bonds or opt for A-rated bonds that offer slightly more risk along with higher interest payments.
Government bonds, and especially bonds from the US government, are considered very low risk. In fact, the US government has never defaulted on its debt payments. However, beware that the interest rates paid on some US government bonds can actually be lower than the rate of inflation for the US dollar.
CDs, or certificates of deposit, are a lot like bonds except that they’re issued by banks. With a CD, you put money into an account for a pre-determined amount of time. CD terms commonly range anywhere from 6 months to 10 years. At the end of the CD term, you get your money back plus an extra amount that represents interest payments.
One important difference between bonds and CDs is that with a CD, you receive all your interest payments at the end of the term instead of once per quarter or once per year. Unlike a traditional savings account, you cannot withdraw your money from a CD whenever you want – you must wait until the end of the CD’s term. In exchange, you receive a higher interest rate than you would for a standard savings account.
3. High-Interest Savings Accounts
A high-interest savings account is just a standard savings account with an above-average interest rate. High-interest savings accounts are offered by many small banks, credit unions, and online-only banks as a way to attract customers.
Just as with a traditional savings account, you can withdraw your money at any time or deposit more money whenever you want. Plus, most high-interest savings accounts are FDIC-insured. So even if your bank goes out of business, your account may be insured for up to $250,000.
4. Preferred Stocks
If you’re looking to invest in stocks, consider preferred stocks. Preferred stocks trade on the stock market alongside common stock, but they operate very differently. Preferred stock entitles you to a guaranteed dividend payment instead of giving you partial ownership in a publicly traded company. In fact, preferred stock is more like a corporate bond than the stock most investors typically think of and that market news focuses on.
Since you only have a claim to this guaranteed dividend and not to a company’s future profits, the price of preferred stock doesn’t change very much in response to earnings reports or other news that drives common stock prices. Preferred stock holders also continue to receive dividend payments even when companies are going through difficult financial times – times when common stock holders often see any their dividend payments suspended or reduced.
5. Mutual Funds
Mutual funds are baskets of stocks, bonds, or other assets. These funds are considered less risky than most individual stocks because you have exposure to a wide range of companies or assets. Even if one company or industry see falling stock prices, the share price of a mutual fund is buffered thanks to the fact that any one company or industry makes up just a small portion of its total portfolio.
However, keep in mind that any mutual fund that invests primarily in stocks is still subject to market-wide price fluctuations. So, in the event of a full market crash, a mutual fund may not be immune from large losses.
6. Money Market Funds
Money market funds are accounts offered by many brokerages as well as some banks that invest your money in a pool of short-term bonds and certificates of deposit. These funds pay interest on your deposits, but the rate can be very low – at the time of writing, the average money market fund pays out around 0.1% APY.
However, funds deposited into money market funds are extremely safe. These accounts are protected with up to $250,000 in FDIC insurance, meaning that the government will step in to return your money in the event your bank or brokerage goes out of business. In addition, you can pull your money out of a money market account at any time. Some banks even offer debit cards for these accounts.
7. “Safe” Stocks and ETFs
Stocks and ETFs (exchange-traded funds) are typically not considered low-risk investments. However, there are some relatively safe stocks that could offer much stronger returns in exchange for moderate risk.
For example, dividend stocks make reliable payouts to investors, and many of these stocks see very few price fluctuations. Look in particular for ‘dividend aristocrats,’ which are stocks that have paid out their dividend consistently for at least 25 years and increased their payouts every single year.
You may also consider “safe” ETFs that invest in a variety of dividend stocks or that invest in stocks with low volatility. These funds allow you to invest in the stock market without being subjected to the swings that make financial headlines every day.
Conclusion: Investments With The Least Risk
Although risk is everywhere in investing, not all investments carry the same level of risk. Nor does risk remain static over time. As a result, it’s possible to invest in low-risk assets that offer the possibility of small rewards and little financial downside. If you’re interested in investing with minimal risk, consider investing in money market funds, CDs, bonds, low-risk stocks and ETFs, and preferred stocks. The 7 low-risk investments we highlighted can help you invest without subjecting you to the up-and-down movements of the stock market.