With the economy facing unprecedented challenges in 2020 due to the coronavirus crisis and the global responses to it, many investors are seeking out stability in their returns, opting for lower-risk investments. Building an investment portfolio that has at least some less-risky assets can be useful in helping you ride out the volatility in the market, and there’s been no shortage of that this year.
The trade-off, of course, is that in lowering risk exposure, investors are likely to see 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, also consider investing strategies that match your long-term goals.
What to consider
Depending on how much you’re willing to risk, there are a couple of scenarios that could play out:
- No risk — You’ll never lose a cent of your principal.
- Some risk — It’s reasonable to say you’ll either break even or incur a small loss over time.
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.
Here are the best low-risk investments in August 2020:
- High-yield savings accounts
- Savings bonds
- Certificates of deposit
- Money market funds
- Treasury bills, notes, bonds and TIPS
- Corporate bonds
- Dividend-paying stocks
- Preferred stock
Overview: Best low-risk investments in 2020
While not technically an investment, savings accounts offer a modest return on your money.
There are a number of accounts available with a 1 percent yield. And you can get a bit more than that if you’re willing to check out the rate tables and shop around.
Why invest: A savings account is completely safe in the sense that you’ll never lose money. Most accounts are government-insured up to certain limits, 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.
Like savings accounts, U.S. savings bonds aren’t investments, strictly speaking.
Rather, they’re “savings instruments,” says Mckayla Braden, former senior adviser for the U.S. Department of the Treasury, which operates TreasuryDirect.gov.
Via TreasuryDirect, the Treasury sells two types of savings bonds: the EE bond and I bond.
“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,” Braden says, referring to an inflation premium that’s revised twice a year.
Why invest: The Series EE savings bonds pay interest up to 30 years, and they earn a fixed rate of return if they were issued in May 2005 or after. If a U.S. savings bond is redeemed before five years, a penalty of the last three months’ interest is charged.
Risk: U.S. savings bonds come with little to no risk, and they may also come with little or no return.
Bank CDs are always loss-proof in an FDIC-backed account, unless you take the money out early.
Why invest: With a CD, the bank promises to pay you a set rate of interest over a specified term if you leave the CD intact until the term ends.
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 usually lose some of the interest you earned. Some banks also hit you with a loss of principal as well, so it’s important to read the rules and check rates before you open a CD.
Money market funds are pools of CDs, short-term bonds and other low-risk investments grouped together to create diversification without much 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 Wacek 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.
The U.S. Treasury also issues Treasury bills, Treasury notes, Treasury bonds and Treasury inflation-protected securities, or TIPS:
- Treasury bills mature in one year or sooner.
- Treasury notes stretch out up to 10 years.
- Treasury bonds mature after up to 30 years.
- TIPS are securities whose principal value goes up or down depending on whether inflation moves up or down.
Why invest: All of these are marketable 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. However, recent volatility in the market and the Fed’s move to lower interest rates to zero mean that some Treasurys may actually have a negative yield. So buying some of these bonds could actually cost you money.
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 “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.”
- Interest-rate risk: The market value of a bond can fluctuate as interest rates change.
- Default risk: The company could fail to make good on its promise to make the interest and principal payments.
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 reputable large companies, or buy funds that invest in these bonds.
Risk: Bonds are generally thought to be lower risk than stocks, though neither asset 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 venture capital, options, futures or precious metals. 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.
Why invest: Stocks that pay dividends are generally perceived as less risky than those that don’t, and they pay out cash.
“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. But in general, it’s lower risk than a growth stock,” Wacek says.
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 stock is more like a lower-grade bond than it is a stock. Still, it may fluctuate substantially if the market falls.
Why invest: Like a bond, preferred stock makes a regular cash payout. But, unusually, preferred stock may be able to suspend this dividend in some circumstances, though often it has to make up any missed payments.
Risk: Preferred stock is like a riskier version of a bond, but is generally safer than a stock. That’s 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.
Featured image by Bloomberg / Getty Images.