Even as inflation comes down and the Federal Reserve has begun to cut interest rates, the economy still faces various risks. Building a portfolio that has at least some less risky assets in it can be useful to help 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 trade-off 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.
Why invest: A high-yield savings account is completely safe in the sense that you’ll never lose money. Most accounts are government-insured up to $250,000 per account type per bank, so you’ll be compensated even if the financial institution fails.
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: These mutual funds will pay out cash interest on a regular schedule, typically monthly. 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. Short-term CDs can offer better liquidity than a longer-term CD, and rates remain attractive even if the Fed has been lowering interest rates.
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 and the rate is variable.
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 less than you otherwise could be. To get a market rate, you’ll need to cancel the CD and will typically have to pay a penalty to do so.
A cash management account is a typical feature at many brokerages, and the accounts can perform a lot of different functions, making them an attractive place to hold cash. The best cash management accounts can be used as checking accounts and savings accounts, and they may offer competitive interest rates while not charging fees. In some cases, a cash management account may be the default account at your brokerage, with the cash held until you decide to invest it in stocks, mutual funds or something else.
Why invest: A cash management account may allow you to earn a competitive interest rate even while your money is available to spend or invest in the stock market. Many cash management accounts offer an automatic sweep, which moves unused cash into a high-yield money market fund. If you decide to invest or spend your money, it’s seamlessly taken out of the money market fund and can be transferred.
Risk: Money market mutual funds are safe, though they don’t have the backing of the FDIC. The interest rate on the accounts is variable, and you’ll need to read the fine print on your account to see what rate you’re getting.
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 in 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. Shorter-term Treasurys are a better bet if you think rates will rise in the near term.
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, an investment advisor representative at CGN Advisors in the Chicago area. “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.
