Every investment comes with some level of risk, but not all investments share the same amount of risk. It’s mostly true that low-risk investments also come with a lower opportunity to make a bigger return on the money you put in, but that’s not always a bad thing. Nor is it always the case for all investments, either.
Sometimes it’s worth taking on risk within an otherwise conservative portfolio; in other cases, it’s more important to hedge against risk with a group of investments designed to provide slow and steady growth.
The good news is that there are plenty of low-risk investments that don’t necessarily sacrifice high returns at the expense of risk aversion. Depending on what kind of portfolio you are willing to build, you may find that certain assets—especially alternative investments—may balance risk and reward quite well.
A certificate of deposit (“CD”) is one of the safest options available to investors. A CD is an interest-bearing savings account. The investment is locked in for a certain period of time, from as few as six weeks to five years or more. In return, the investor receives a fixed interest rate for the duration of the investment. In return for the reduced liquidity, the interest rate on a CD is higher than the prevailing interest rate for a high-yield savings account. Unlike other investments, CDs are also FDIC insured up to $250,000.
CDs are a good option for the cautious investor who is looking to safeguard their principal. Investors receive a fixed, periodic interest payment for a predetermined period of time with virtually no risk of losing money on their initial investment. A major downside of CDs is the loss of liquidity. This is compounded by the fact that returns are extremely low, given today’s ultra-low interest rate environment. Currently, average rates on even long-duration CDs are below inflation. Fortunately, for investors willing to accept a bit more risk for a better return, there are other options available.
U.S Government bonds are another popular low-risk investment option that gets a significant amount of attention from investors looking to add security into their portfolio. With government bonds, municipal or federal agencies solicit investments in order to help fund projects, fill budget gaps, or engage in other public ventures. These bonds offer investors a fixed return on their investment and a maturity date by which the bondholder will be returned their initial principal.
Bonds are rated by credit rating agencies. The credit rating captures the likelihood that the issuer will default on its debt, or fail to make scheduled payments. The higher the rating, the lower the likelihood that an investor will lose their initial principal. U.S. Treasury bonds are considered the “gold standard” of low-risk bond investments, as the bonds are backed by the full faith and credit of the U.S. government. However, yields on many government bonds are at an all-time low, making these less attractive for many investors. Corporate bonds offer a higher yield, but this is accompanied in most cases by a higher risk of default.
Preferred stock (or “prefs”) is a special class of stock that offers many of the benefits of bond ownership combined with higher yields. Unlike common stock, where dividends are set annually at the discretion of a company’s board of directors, preferred stock is issued with a fixed dividend specified as a percentage of the issuance price. If the company is unable to make dividend payments, the dividends of preferred stock typically accrue and are paid in arrears. Preferred shareholders receive their dividend before common shareholders, and are also ahead of common stock in the event of a restructuring or bankruptcy.
Preferred stock ownership comes with some risks. Similar to owning common stock, prefs are subject to market risk and are vulnerable to company under-performance. However, because of their fixed dividend payment, preferred shares tend to trade around their face value. The downside is that investors don’t benefit from company outperformance, while the upside is that they are less likely to lose their principal. Like bonds, prefs are subject to interest rate risk, with the market value declining as rates rise.
CDs, bonds and preferred shares are among the more common low-risk investment opportunities around, but they’re far from the only ones. Another strong option for people seeking low-risk investments is farmland investing.
With farmland investing, people are able to add diversification to their portfolio in several ways. First, farmland investing offers an alternative to investments in the stock market, which can come in handy if a person’s portfolio is primarily composed of stocks and funds. Second, farmland investing includes a real estate component by way of farmland value, which has been historically good at retaining value despite external market ups-and-downs. Third, farmland investing can pay dividends as well, creating a passive income stream.
Unlike other low-risk investment opportunities, farmland investing can offer a considerable return for participants as well. For example, government bonds are currently returning below 2 percent, whereas farmland investing has historically returned 8 to 12 percent. Both minimize risk, but the upside of farmland investing can be considerably higher than this and other alternatives.
An index fund is a portfolio of stocks or bonds that is designed to track the performance of an existing index, like the S&P 500 or the Russell 1000. Index funds are an excellent way for everyday investors to have the benefit of stock ownership with fewer risks than picking individual stocks. Instead of running the risk of investing in a company that under-performs (or worse, goes bankrupt), buying an index fund allows investors to increase the diversification of their portfolio and benefit from the growth of the market as a whole.
For many years, investors’ main access to index funds was through mutual funds, which are funds managed by professional investment managers. More recently, investors have been able to gain exposure to index funds through purchasing exchange traded funds (ETFs). ETFs are a lower-fee option that can be bought and sold on the market like a stock. Both passively managed mutual funds and ETFs are a good option for investors looking for diversification and solid long-term returns.
It’s worth remembering that an index fund’s return won’t beat the market, only match it. Additionally, index funds are still subject to market risk, and investors can lose their principal in the event of a market-wide downturn.
There is no such thing as risk-free investment. Any time you put money into a venture that offers you a chance to earn more than you put in, there’s a chance that things may not pan out as you’d hoped they would. That said, not every investment is made equally in terms of risk. Some offer a smaller return in exchange for less risk; others offer a tantalizing return for investors with a strong stomach and a bigger appetite for risk.Not every investment falls into the low-risk low-reward or high-risk high-reward dichotomy, however. Some investments strike a balance between a high return and a palatable amount of risk. One of the strongest among these is farmland investing—especially when partnering with FarmTogether to help you learn the ropes.
Disclaimer: FarmTogether does not intend to provide tax, legal or investment advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and investment advisors before engaging in any transaction.