Where to Find Low Risk Investment Options
What to expect when seeking low risk investments.
Everything in life is about trade-offs. With low risk investment choices, you are unlikely to lose your principal, but you are also unlikely to earn a very high rate of return. If this is the kind of trade-off you are looking for, then below are seven low risk investment options to consider.
1. Bank Savings
A savings account at your bank or credit union is low risk. Your account value is not going to fluctuate. Yet you can lose money in a slow and steady way, like erosion. If your savings account is paying you 1 percent, and inflation is 3 percent, you are losing 2 percent a year in purchasing power. Bank saving accounts are the best choice when you need access to your money at any time.
2. Certificates of Deposit (CDs)
Banks issue certificates of deposit that guarantee you a specific interest rate over a specific term, such as six months, one year, or five years. If you withdraw the money before the end of the term, a penalty may apply. Like savings accounts, CDs are low risk. CDs can be a good place to park money for a purchase you know you will need to make at a specific time in the future.
3. Treasury Securities
The U.S. Government issues numerous types of securities, all considered low risk investments. There are EE Bonds, I Bonds, TIPS, Treasury Bonds, Treasury Bills and Treasury Notes. You buy these types of investments electronically directly from the U.S. Treasury through an online account. I have such an account, which is linked to my checking account.
4. Money Market Accounts
Your bank may offer a money market account which may pay a slightly higher interest rate than a standard savings account. You may be required to keep a minimum balance to qualify for the higher interest rate. Money market accounts are slightly different than money market funds.
5. Stable Value Funds
Stable value is an investment option that is available within most (but not all) 401(k) plans. It is a low risk investment with an objective of preserving your principal, providing liquidity so you can transfer out of it at anytime, and achieving returns comparable to short and intermediate term bonds but with less volatility (less up and down fluctuations). Most near retirees should consider stable value as part of their portfolio within their 401k plan.
6. Fixed Annuities
Fixed annuities are issued by an insurance company. They are low risk because the insurance company contractually agrees to pay you a fixed interest rate. A fixed annuity is like a CD except the interest accumulates tax-deferred. Unlike a CD you'll pay a penalty tax if you withdraw the interest before you reach age 59 ½. The interest rate guarantee is only as good as the insurance company issuing it. Your money in an annuity is exposed to some risk if the insurance company goes out of business. If you are under the state guaranty limits, your money should still be protected.
Fixed annuities are a good choice is you are in a high tax bracket, want your money to be safe, and won't need to use it until 59 1/2 or later.
7. Immediate Annuities
An immediate annuity guarantees you a specific monthly amount of income. Just as with the fixed annuity the guarantee is only as good as the insurance company issuing it. Your money in an annuity is exposed to some risk if the insurance company goes out of business. If you are under the state guaranty limits, your money should still be protected. Immediate annuities are the best choice when you are older and want income guaranteed to last the rest of your life.
Returns and Risk Expectations for Low Risk Investments
It is unrealistic to expect high returns from low risk investments. There is no free lunch and investments that offer the potential for higher returns also come with a higher degree of risk. To understand risk I think it makes sense to measure investment risk on a scale of 1 to 5, with a five being a high risk choice, and one being a safe choice. The investments described in the list above would be categorized as a 1 or 2 on such a scale.
When to Go for the Low Risk Choice
Low risk investments are the optimal choice for all of the following situations:
- You don't know what else to do with your money right now.
- It is for your emergency fund.
- You may need to use the money in less than ten years.
If you are investing money you won't need to use within the next ten years you may want to consider something that offers the potential for a higher return, which may also entail taking on additional risk.
The process of building a portfolio means you thoughtfully select investments with different levels of risk so they work together toward a common goal.