Which Type of Investment Has the Lowest Risk?

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Stock investing can be risky, but it's often an integral part of long-term financial planning. Stock prices fluctuate, and returns are never guaranteed, but the average annual stock market return over the past century has been about 10%. Still, investing only in the stock market can be uncomfortably risky for many investors. Low-risk investments, on the other hand, generally produce smaller returns, but they hold an important place in a balanced portfolio, especially as you get closer to retirement.

What are the best low-risk investments? Here are some options that may be appealing to risk-averse investors.

What Are Low-Risk Investments?

Low-risk investments offer investors peace of mind because they are structured so you are unlikely to lose your money when you invest in them. The measures taken to ensure their safety, however, also mean they are not likely to earn high returns. Here are some popular low-risk investments.

Savings Accounts

Certain financial products provide more liquidity than others. This is precisely why keeping your emergency fund in a savings account is ideal: If a surprise expense pops up and you need money now, you'll be able to easily access those funds without much fuss.(Just keep in mind that your bank may limit the number of electronic withdrawals or transfers you can make from a savings account every month.)

Among savings accounts, a high-yield savings account will likely provide the best return on your investment. It's an interest-earning account you can open at some banks, credit unions and online financial institutions. While the national average interest rate on savings accounts was just 0.06% in December 2021, according to the Federal Deposit Insurance Corporation (FDIC), some high-yield savings accounts offer rates as high as 0.5%.

Certificates of Deposit (CDs)

A CD is a type of savings vehicle that typically offers a higher interest rate than a traditional savings account by requiring you to leave your money in the account for a certain time period. Generally speaking, the longer you give up access to your investment, the higher the interest rate will be. This maturity period typically lasts anywhere from one month to five years or more; after that, you'll get back your initial investment plus interest. In December 2021, the national average interest rate for a six-month CD was 0.09%, while a 60-month CD's rate was 0.28%, according to the FDIC.

There are different types of CDs, but most charge a penalty if you withdraw funds before the maturity period ends. The penalty is usually based on the account's interest and terms. If your term is over 24 months, for example, a bank may charge you 12 months' worth of interest.

Money Market Accounts

A money market account earns interest like a savings account but provides greater flexibility with your money. Account holders can usually write checks and may have the ability to make ATM withdrawals or use a debit card. Interest compounds at a predetermined interval, which can be daily, monthly or annually, for example.

One downside is that you may have to make a minimum deposit or maintain a minimum account balance to avoid fees. Like a savings account, the number of electronic transfers or withdrawals you can make each month may be limited. The national average money market account interest rate as of December 2021 was 0.07%, according to the FDIC.

Bonds

Bonds are debt securities that are used by government entities and corporations to raise money. When you buy a bond, you're basically lending money to the organization that issued it. The bond is then repaid with interest. The maturity date determines when you can expect full repayment, but interest might be doled out along the way.

Bonds are structured in a way that doesn't provide much liquidity, so they aren't ideal for people who think they may need that money prior to the maturity date.

Lower-Risk Ways to Invest in Stocks

Putting your money into individual company stocks is one of the most volatile ways to invest—but it isn't the only way to invest in the stock market. If you hope to earn a higher return than a savings account offers and aren't opposed to a bit more risk to try to achieve it, the options below may be worth considering.

Exchange-Traded Funds (ETFs)

An ETF is a fund of investments that can include a mix of stocks, bonds and other assets. They're similar to individual stocks in that their value can fluctuate and they can be bought or sold at any time, but they're considered less risky because they invest in a range of securities, rather than a single company stock. ETFs typically track specific market indexes, like the S&P 500, and as such are usually passively managed.

ETFs make for attractive investments, thanks to their relatively low cost. What's more, ETFs can help diversify your investment portfolio as they're available across most sectors and asset classes.

Mutual Funds

Mutual funds are similar to ETFs in that both are batches of investments consisting of different holdings. What sets mutual funds apart is that they are actively managed (with the exception of index funds) and their value is assessed at the end of each trading day; ETFs' valuations fluctuate throughout the day. Mutual funds are designed for "buy and hold" investing with the hope of outperforming the market over the long term.

Pros and Cons of Low-Risk Investments

Pros

  • They can help balance your investment portfolio. Low-risk investments can help shore up your portfolio if some investments don't perform as well as expected. Aiming for 60% stocks and 40% bonds is one rule of thumb. Investment research company Morningstar found that over the past decade, the average annualized return for this type of portfolio is about 10%. As you get close to retirement, putting more of your money into lower-risk investments can help you preserve the returns you've earned.
  • Some are ideal for short-term saving. High-yield savings accounts and money market accounts can make good homes for your emergency fund. CDs can also provide some return on investment if you're saving for a short-term financial goal, such as a down payment on a home.
  • There's less uncertainty. Low-risk investments aren't nearly as volatile as stocks. They're also much more transparent with regard to the kinds of returns you can expect.

Cons

  • Returns are typically less robust when compared with stocks.
  • With low-risk vehicles like CDs and bonds, you're sacrificing liquidity until those investments mature.
  • Stock investing can help you keep pace with inflation, which may not be the case with low-risk investments.

When to Choose a Low-Risk Investment Over a High-Risk Investment

Low-risk investments don't typically generate huge returns, but you may want to opt in if any of the following apply to you:

  • Your portfolio is heavy on high-risk investments and you want to offset potential losses.
  • You need a place to park your emergency fund.
  • You have a low appetite for risk but still want to invest.

The best approach is usually to hold a wide range of investments. If stock investments lead to losses, you'll have some safer investments in the mix to keep things afloat. When stocks perform well, your money can grow faster. That's especially handy where inflation is concerned.

The Bottom Line

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