Even as inflation comes down and the Federal Reserve begins to cut interest rates, the economy still faces the risk of a recession. Building a portfolio that has at least some less risky assets can be useful in helping you ride out volatility in the market.
The trade-off, of course, is that in lowering risk exposure, investors are likely to earn lower returns over the long run. That may be fine if your goal is to preserve capital and maintain a steady flow of interest income.
But if you’re looking for growth, consider investing strategies that match your long-term goals. Even higher-risk investments such as stocks have segments (such as dividend stocks) that reduce relative risk while still providing attractive long-term returns.
There are, however, two catches: Low-risk investments earn lower returns than you could find elsewhere with risk; and inflation can erode the purchasing power of money stashed in low-risk investments.
If you opt for only low-risk investments, you’re likely to lose purchasing power over time. It’s also why low-risk plays make for better short-term investments or a stash for your emergency fund. In contrast, higher-risk investments are better suited for long-term goals.
While not technically an investment, savings accounts offer a modest return on your money. You’ll find the highest-yielding options by searching online, and you can get a bit more yield if you’re willing to check out the rate tables and shop around.
Risk: Cash doesn’t lose dollar value, though inflation can erode its purchasing power.
Money market funds are pools of CDs, short-term bonds and other low-risk investments grouped together to diversify risk, and are typically sold by brokerage firms and mutual fund companies.
Why invest: Unlike a CD, a money market fund is liquid, which means you typically can take out your funds at any time without being penalized.
Risk: Money market funds usually are pretty safe, says Ben Wacek, founder and financial planner of Guide Financial Planning in Minneapolis.
“The bank tells you what rate you’ll get, and its goal is that the value per share won’t be less than $1,” he says.
Bank CDs are always loss-proof in an FDIC-backed account, unless you take the money out early. To find the best rates, you’ll want to shop around online and compare what banks offer. With interest rates rising substantially in recent years, it may make sense to own short-term CDs and then reinvest if rates move up. You’ll want to avoid being locked into below-market CDs for too long.
An alternative to a short-term CD is a no-penalty CD, which lets you dodge the typical penalty for early withdrawal. So you can withdraw your money and then move it into a higher-paying CD without the usual costs.
Why invest: If you leave the CD intact until the term ends the bank promises to pay you a set rate of interest over the specified term.
Some savings accounts pay higher rates of interest than some CDs, but those so-called high-yield accounts may require a large deposit.
Risk: If you remove funds from a CD early, you’ll typically lose some of the interest you earned. Some banks also hit you with a loss of a portion of principal as well, so it’s important to read the rules and check CD rates before you invest. Additionally, if you lock yourself into a longer-term CD and overall rates rise, you’ll be earning a lower yield. To get a market rate, you’ll need to cancel the CD and will typically have to pay a penalty to do so.
A Series I savings bond is a low-risk bond that adjusts for inflation, helping protect your investment. When inflation rises, the bond’s interest rate is adjusted upward. But when inflation falls, the bond’s payment falls as well. You can buy the Series I bond from TreasuryDirect.gov, which is operated by the U.S. Department of the Treasury.
“The I bond is a good choice for protection against inflation because you get a fixed rate and an inflation rate added to that every six months,” says McKayla Braden, former senior advisor for the Department of the Treasury, referring to an inflation premium that’s revised twice a year.
Why invest: The Series I bond adjusts its payment semi-annually depending on the inflation rate. With high inflation levels, the bond is paying out a sizable yield. That will adjust higher if inflation continues to rise, too. So the bond helps protect your investment against the ravages of increasing prices.
Risk: Savings bonds are backed by the U.S. government, so they’re considered about as safe as an investment comes. However, don’t forget that the bond’s interest payment will fall if and when inflation settles back down.
If a U.S. savings bond is redeemed before five years, a penalty of the last three months’ interest is charged.
The U.S. Treasury also issues Treasury bills, Treasury notes, Treasury bonds and Treasury inflation-protected securities, or TIPS:
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Treasury bills mature in one year or sooner.
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Treasury notes stretch out up to 10 years.
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Treasury bonds mature up to 30 years.
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TIPS are securities whose principal value goes up or down depending on the direction of inflation.
Why invest: All of these are highly liquid securities that can be bought and sold either directly or through mutual funds.
Risk: If you keep Treasurys until they mature, you generally won’t lose any money, unless you buy a negative-yielding bond. If you sell them sooner than maturity, you could lose some of your principal, since the value will fluctuate as interest rates rise and fall. Rising interest rates make the value of existing bonds fall, and vice versa.
Companies also issue bonds, which can come in relatively low-risk varieties (issued by large profitable companies) down to very risky ones. The lowest of the low are known as high-yield bonds or “junk bonds.”
“There are high-yield corporate bonds that are low rate, low quality,” says Cheryl Krueger, founder of Growing Fortunes Financial Partners in Schaumburg, Illinois. “I consider those more risky because you have not just the interest rate risk, but the default risk as well.”
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Interest-rate risk: The market value of a bond can fluctuate as interest rates change. Bond values move up when rates fall and bond values move down when rates rise.
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Default risk: The company could fail to make good on its promise to make the interest and principal payments, potentially leaving you with nothing on the investment.
Why invest: To mitigate interest-rate risk, investors can select bonds that mature in the next few years. Longer-term bonds are more sensitive to changes in interest rates. To lower default risk, investors can select high-quality bonds from large, reputable companies, or buy funds that invest in a diversified portfolio of these bonds.
Risk: Bonds are generally thought to be lower risk than stocks, though neither asset class is risk-free.
“Bondholders are higher in the pecking order than stockholders, so if the company goes bankrupt, bondholders get their money back before stockholders,” Wacek says.
Stocks aren’t as safe as cash, savings accounts or government debt, but they’re generally less risky than high-fliers like options or futures. Dividend stocks are considered safer than high-growth stocks, because they pay cash dividends, helping to limit their volatility but not eliminating it. So dividend stocks will fluctuate with the market but may not fall as far when the market is depressed.
Why invest: Stocks that pay dividends are generally perceived as less risky than those that don’t.
“I wouldn’t say a dividend-paying stock is a low-risk investment because there were dividend-paying stocks that lost 20 percent or 30 percent in 2008,” Wacek says. “But in general, it’s lower risk than a growth stock.”
That’s because dividend-paying companies tend to be more stable and mature, and they offer the dividend, as well as the possibility of stock-price appreciation.
“You’re not depending on only the value of that stock, which can fluctuate, but you’re getting paid a regular income from that stock, too,” Wacek says.
Risk: One risk for dividend stocks is if the company runs into tough times and declares a loss, forcing it to trim or eliminate its dividend entirely, which will hurt the stock price.
Preferred stocks are more like lower-grade bonds than common stocks. Still, their values may fluctuate substantially if the market falls or if interest rates rise.
Why invest: Like a bond, preferred stock makes a regular cash payout. But, unusually, companies that issue preferred stock may be able to suspend the dividend in some circumstances, though often the company has to make up any missed payments. And the company has to pay dividends on preferred stock before dividends can be paid to common stockholders.
Risk: Preferred stock is like a riskier version of a bond, but is generally safer than a stock. They are often referred to as hybrid securities because holders of preferred stock get paid out after bondholders but before stockholders. Preferred stocks typically trade on a stock exchange like other stocks and need to be analyzed carefully before purchasing.
A money market account may feel much like a savings account, and it offers many of the same benefits, including a debit card and interest payments. A money market account may require a higher minimum deposit than a savings account, however.
Why invest: Rates on money market accounts may be higher than comparable savings accounts. Plus you’ll have the flexibility to spend the cash if you need it, though the money market account may have a limit on your monthly withdrawals, similar to a savings account. You’ll want to search for the best rates here to make sure you’re maximizing your returns.
Risk: Money market accounts are protected by the FDIC, with guarantees up to $250,000 per depositor per bank. So money market accounts present no risk to your principal. Perhaps the biggest risk is the cost of having too much money in your account and not earning enough interest to outpace inflation, meaning you could lose purchasing power over time.
An annuity is a contract, often made with an insurance company, that will pay a certain level of income over some time period in exchange for an upfront payment. The annuity can be structured many ways, such as to pay over a fixed period such as 20 years or until the death of the client.
With a fixed annuity, the contract promises to pay a specific sum of money, usually monthly, over a period of time. You can contribute a lump sum and take your payout starting immediately, or pay into it over time and have the annuity begin paying out at some future date (such as your retirement date.)
Why invest: A fixed annuity can provide you with a guaranteed income and return, giving you greater financial security, especially during periods when you are no longer working. An annuity can also offer you a way to grow your income on a tax-deferred basis, and you can contribute an unlimited amount to the account. Annuities may also come with a range of other benefits, such as death benefits or minimum guaranteed payouts, depending on the contract.
Risk: Annuity contracts are notoriously complex, and so you may not be getting exactly what you expect if you don’t read the contract’s fine print very closely. Annuities are fairly illiquid, meaning it can be hard or impossible to get out of one without incurring a significant penalty. If inflation rises substantially in the future, your guaranteed payout may not look as attractive either.
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
