You know the saying, “High risk, high reward” – but what if you’re looking for something safer that still fits into the investment goals you set for yourself with your portfolio? That’s why this article will discuss five popular ideas for a low-risk investment.
What is Risk?
As defined by the official website of the United States government, “In finance, risk refers to the degree of uncertainty or potential financial loss inherent in an investment decision.” So, the higher the risk, the more likely you lose some of your money or the asset doesn’t perform as expected.
When looking at risk, there are multiple types of risk one has to keep in mind. Here are some of main types:
Business risk – When you have stocks or bonds from a specific company, there’s the inherent risk that this business becomes insolvent.
Market risk – Sometimes the whole market goes down – as we have seen in the past few weeks. Some asset classes don’t follow the trend when this happens, a prime example being the inverse proportional correlation of stocks and gold. However, if you were invested in stocks, you would have to shoulder the risk of your investment going (temporarily) down if the whole market is on a downtrend.
Inflation risk – We recently covered how you can protect against inflation and what it is. In essence, inflation is the devaluation of your money and the rise in prices. When inflation increases, so should the return on your investments; otherwise, you’re losing purchasing power.
What Does Low-Risk Mean to You?
Of course, there are some ways to objectify risk, like the score that ratings agencies apply to governmental bonds. This is an excellent supporting tool to gauge the risk without needing to do much in-depth research. Still, what seems like a low-risk investment to one person, could be above the threshold for someone else – and vice versa.
Inflation risk and seeing your money devalue over time is reason enough for many investors to seek out investments that produce high returns. Even if they don’t offer the same safety as other assets, it makes sense for this group of investors since the risk of “losing” money due to inflation is very real.
So, in the end, it comes down to the question of if you would rather take the risk of inflation or the risk of the asset not performing as expected. High inflation rates set the bar for a “low-risk investment” much lower than usual.
5 Low-Risk Investment Options
In the following section, we’ll highlight five investment options that many people consider to be low risk. Whether they fit into your definition of low risk or not is something you will have to define for yourself:
1. Bank account – Is This Really a Low-Risk Investment?
A bank account is often viewed as the safest way to store your money. And it’s true – it’s great if you want to keep it safe from thieves and don’t want its nominal value to decrease. Yet, many people see it as a form of investment because they receive, or used to receive, interest on their balance.
In reality, the net interest is generally negative – especially in current times where many bank accounts in Europe offer interest rates close to 0%, whilst inflation is at 7%+. So while on paper you potentially gain money, in the real world, you lose money, as everything gets more expensive without your money growing by the same amount.
2. Governmental and Corporate Bonds
Another popular way to invest money with relatively low risk is bonds. Bonds are used when a company or government is looking for funding but doesn’t want to issue stock or give up equity. With bonds, you mostly get a fixed interest rate, and at the end of the term, you receive the principal back.
Bonds can be rated by a rating agency, which lets you see how likely it is that the issuer will fulfil their duties of the bond and not default. For example, Germany has a AAA bond rating, and Estonia has a rating of AA-. This safety comes with a price though, with the current interest rates for a German 10-year bond hovering around just 1%.
3. Dividend Stocks
Whether stocks are a low-risk investment or not can be up for debate. With dividend stocks, you profit off the dividends these stocks issue to their shareholders every quarter, half-year or year. Dividend stocks generally have smaller price fluctuations than growth stocks because a significant portion of the profit is distributed to shareholders.
Companies like Coca-Cola, Johnson & Johnson and Microsoft, all well-established businesses in their field, offer regular dividend payments to shareholders. Depending on your risk level and goals, this might be a suitable option for you, as yields can be between 1% and 2.5%.
4. Index Funds
An alternative is index funds that mirror a specific market index. If you invest in an index fund, sometimes called an ETF, you mitigate the business risk and sector risk because your investment is distributed over many different stocks, thereby increasing diversification.
Index funds can be more volatile than an individual bond or dividend stock from a big company because they replicate the whole market. If there’s certainty in the stock market, then prices increase; if there’s fear and people sell, it’ll fall. But many people value that approach because diversification minimizes portfolio risk while still offering returns. The S&P 500, for example, has had an inflation-adjusted return rate of 7.59% since 1950.
5. P2P Lending
P2P lending is a relatively new asset class being offered to retail investors. With this investment type, you can directly invest in various loans like consumer or real estate-backed loans, or instead invest in the loan originators themselves.
The platforms offering P2P loans have return rates that can rival (or exceed) the inflation rate. Yet, how can this be a low-risk investment? One way to add security to investors is through the loan originators offering a buyback guarantee. If a loan goes over a certain period without being paid back by the borrower, the loan originator will buy back the loan and pay any outstanding interest.
If you’re looking to judge whether P2P lending fits your risk level, one good way is to analyze the loan originator. Do they have enough liquid funds? What does their yearly report look like? How long have they been in business?
If the answers satisfy you, this might be a viable option with a relatively low risk.