Any financial advisor will tell you that there are no risk-free investments. Every type of investment, even those with guaranteed returns, carries some risk. It is important to understand your market exposure and strategy when choosing where to put your money. However, there are several types of low risk investments which can yield substantial returns. Here are a few things to consider when deciding which type of investment has the lowest risk for your portfolio.
Different Kinds of Risk
The biggest mistake you can make as an investor is ignorance. Simply labeling an investment “safe” or “risky” is an oversimplification which could leave you vulnerable. There are several types of risks associated with investing, so take some time to educate yourself of which ones apply to your investments.
The most common associated risks are a result of the market losing value or losses due to changes in interest rates. Additionally, nearly all investments also lose capital due to taxation. However, there are also less obvious risks that could affect your portfolio. These include losses from political actions, new legislation, inflation and purchasing power, or lower returns on reinvestment. If you are uncertain of your current exposure, discuss your concerns with a financial advisor.
Low Risk Investments
1. Dividend- Paying Stocks and Preferred Stocks
When you buy ownership shares in a company, shareholders routinely receive a portion of the profits. These dividends are usually paid out on a quarterly or monthly basis. Dividend-paying stocks also have the added bonus of participation in capital gains. The combination of these capital gains and dividends can protect your from short term fluctuations and lead to impressive long term yields.
Preferred stocks carry even less risk since these shares receive priority over common dividend-paying stocks. Not only do you jump the line to receive your payout, but they generally have higher dividend yields as well.
However, the risk of market fluctuation affects companies and investors alike. When stock prices fall, so do your dividends. Furthermore, companies have no legal obligation to pay dividends. This can be especially problematic if a company falls on hard times or declares bankruptcy. Not only will you lose money when stock prices fall, but you have the added losses if you sell them for less than the original purchasing price. If you decide to wait it out, it could be quite some time before you receive your dividends.
2. Utility Stock
Utility stocks are an excellent choice for investors and one type of investment that has the lowest risk. Prices tend to be stable and pay out dividends between 2-3% more than treasury securities. These are considered non-cyclical stocks because there will always be a need for electricity, water and gas regardless of economic conditions.
The benefits of these stocks are that they are fully liquid and can be sold without penalty. However, they do have more risks than preferred stocks and are subject to taxation. When choosing which stocks to purchase, be sure to check national ratings agencies. These kinds of stocks have a grading system similar to bonds and preferred issues. These agencies are a great way to guide your toward the best investments for you.
Choosing annuities investments is complicated even for experienced investors or financial planners. In essence, they are investment contracts with insurance companies. In exchange for your capital, you receive a guaranteed return at the predetermined rate. This can be either a fixed or variable rate. These instruments allow investors to contribute virtually unlimited amounts that can grow tax-deferred until you reach retirement.
As a rule of thumb, the higher your guaranteed return, the higher your risk. Annuities are not insured by the FDIC, however they are backed by the insurance company issuing them. Often times, other insurance companies will also back annuities for added security. The greatest risks with annuities stem from penalties for early withdrawals, losses due to interest rates, and loss of purchasing power from inflation. Depending which ones you choose, many investors consider annuities a low risk investment.
4. Certificates of Deposit (CDs)
Brokered CDs, or Certificates of Deposit, are a popular choice for ultra-conservative investors who want to protect their principal. Banks and private brokers offer CDs because they provide immediate cash to lend and use for a set period of time. They usually come with higher rates than traditional savings accounts as well. They are issued like bonds and backed by the FDIC if they reach maturity.
The greatest drawback of investing in CDs is that you must pay a withdrawal penalty if you access the account early. Additionally, if you sell them early then you receive less than the face value through a secondary market. All in all, CDs are one type of investment that has the lowest risk to investors.
5. Treasury Securities
One of the first types of investments many Americans receive are Treasury securities in the form of notes, bills, and bonds. When you invest in Treasury securities, you are giving a loan to the federal government. In return, you receive interest on that loan at regular intervals. If you wait the full period, you will also receive the face value of your investment in addition to the interest accrued.
If you are uncertain of the differences between notes, bills, and bonds, the answer is time and interest rates. Bills must be repaid within a year. Notes have repayment plans up to ten years. Bonds are the longest investment with repayment after either 20 or 30 years.
Treasury securities are low-risk investments because they are backed by the federal government. However, if you sell them before they reach maturity, you will lose out on those interest payments. A Golden Butterfly Portfolio is a good portfolio because it is made up of 20% Long-Term Treasury Bonds 20% Short-Term Treasury Bonds.
Evaluate Lowest Risk Investment Strategies
There are several options for people looking for low risk investments. Remember, completely risk-free investments do not exist. However, there are ways to limit your losses and market exposure. If you need more information or help to decide what is best for you, speak with a financial advisor.