Low-Risk Investments: Where To Begin And What To Know

Low-risk investments are a great way to grow your money faster than a traditional savings account without risking too much. They are ideal for risk-averse individuals who want to grow their money without the possibility of losing everything.

Some of the most common low-risk investments include high-yield savings accounts, money market funds, treasury securities, certificates of deposit, and corporate and government bonds. These options offer more predictability and security but limited growth potential.

When considering low-risk investments, it is important to understand your financial goals, risk tolerance, and time horizon. Additionally, diversification can help protect your investments by spreading the risk across various assets and industries.

While low-risk investments provide stability, they typically generate lower returns than high-risk investments. It is also important to note that even low-risk investments carry some level of risk, and the value of your investment may fluctuate or be affected by inflation.

Understand your risk tolerance

Understanding your risk tolerance is a key step in determining your investment strategy. Risk tolerance is the amount of market volatility and loss you're willing to accept as an investor. It's influenced by your financial situation, goals, and personality. Here are some factors to consider when assessing your risk tolerance:

• Investment objectives: Are you investing for growth, income, or capital preservation? Higher-risk investments offer the potential for significant growth but also carry a higher risk of loss. Lower-risk investments may not provide the desired level of growth but are less likely to result in significant losses.
• Investment time horizon: If you're investing for the long term, such as for retirement, you may be able to tolerate more risk as you have time to recover from any losses. For shorter-term goals, such as saving for a down payment on a house, you may need to be more conservative to avoid losing value just before you need to withdraw your funds.
• Reliance on invested funds: Consider whether you're relying on this money for essential expenses, such as a home down payment or education costs. If so, you may want to choose lower-risk investments to protect your capital.
• Financial circumstances: Evaluate your short-term and long-term spending requirements, including routine expenses (e.g., housing, food), emergency expenses (e.g., repairs, medical care), and potential future expenses (e.g., buying a car or house). Your financial ability to take risks will depend on your overall financial situation and how much money you can afford to lose.
• Personality: Your inherent personality also plays a role in risk tolerance. Some people are naturally more cautious, while others are more comfortable taking risks. While your financial situation is important, your comfort level with risk should also be considered. If you're uncomfortable with the idea of losing money, you may want to avoid high-risk investments to prevent early withdrawals due to volatility.

It's important to note that your risk tolerance is personal and may change over time as your financial situation and goals evolve. Regularly reviewing your investment portfolio and risk tolerance can help you make informed decisions and adjust your strategy accordingly.

Diversify your investments

Diversifying your investments is a crucial strategy to balance risk and reward. Here are some ways to achieve diversification:

Spread the Wealth

Diversification is about not putting all your eggs in one basket. Invest across different asset classes, such as stocks, bonds, commodities, exchange-traded funds (ETFs), and real estate investment trusts (REITs). Consider investing globally to spread your risk and potentially reap bigger rewards. Aim for a manageable portfolio of around 20 to 30 different investments.

Index and Bond Funds

Index funds and fixed-income funds are great additions to your portfolio. Index funds track various indexes and aim to match the performance of broad markets, providing diversification at low fees. Bond funds, on the other hand, provide diversification by investing in a range of bonds, reducing individual bond default risk.

Regularly Add to Your Portfolio

Use dollar-cost averaging to invest a fixed amount regularly. This strategy smooths out market volatility, helping you buy more shares when prices are low and fewer when prices are high.

Know When to Exit

Stay informed about your investments and overall market conditions. This awareness will help you decide when to cut losses and move on to other opportunities.

Monitor Commissions

Understand the fees you're paying, whether monthly or transactional. While $0 commission trading is now common for stocks and ETFs, other investments like mutual funds, illiquid stocks, and alternative asset classes may incur fees.

By diversifying your investments, you reduce the risk of significant losses and improve the chances of long-term growth. However, remember that diversification does not guarantee profit or eliminate risk entirely.

Choose a financial advisor

Choosing a financial advisor is a crucial step in achieving your financial goals. Here are some detailed and instructive guidelines to help you select the right financial advisor for your low-risk investment journey:

Identify your financial needs:

Before beginning your search, reflect on your financial objectives and the specific areas where you need guidance. Financial advisors offer diverse services, so understanding your requirements will help you find the right fit. Some common areas where financial advisors provide guidance include personal finance, debt management, investing, tax strategy, retirement planning, and estate planning. Knowing your priorities will help you decide between an online or traditional financial advisor and save you from paying for unnecessary services.

Understand advisor credentials:

Financial advisors go by various titles, but not all titles are tied to specific credentials. Look for advisors with certifications such as Certified Financial Planner (CFP) or Registered Investment Advisors (RIA). CFPs have a fiduciary duty to their clients, and RIAs are regulated and bound by fiduciary duty. These advisors are legally obligated to act in your best interest.

Review advisor service types:

Financial advisors offer their services through different channels. You can choose between online financial planners, traditional in-person financial planners, robo-advisors, or online financial planning services with access to human advisors. The right choice depends on your budget, preference for in-person or virtual meetings, and the level of financial guidance you need.

Evaluate affordability:

Financial advisors have varying fee structures, so it's essential to understand their costs before engaging their services. Robo-advisors often charge a low annual fee, typically around 0.25% to 0.50% of your account balance. Online financial planning services may charge a flat subscription fee, a percentage of assets, or a combination of both. Traditional in-person financial advisors usually charge higher fees, often about 1% of your assets under management.

Vet the advisor's background:

It's crucial to verify an advisor's credentials and experience. Check their Form ADV, which all investment advisors must complete for federal and state registration. Review their Client Relationship Summary (Form CRS) and advisory brochure to understand their services, fees, and any potential conflicts of interest. Additionally, utilize the Financial Industry Regulatory Authority's (FINRA) online tool to check for certifications, registrations, complaints, or disciplinary actions involving the advisor.

Set up an initial meeting:

Once you've narrowed down your options, schedule a meeting with your top candidates. Come prepared to discuss your financial situation, goals, risk tolerance, and communication preferences. This meeting will help you determine if the advisor is a good fit and if they can clearly explain their investment approach and strategies.

Remember, choosing the right financial advisor depends on your unique financial circumstances and goals. Take the time to research and ask questions to ensure you find an advisor who understands your needs and can guide you effectively toward achieving your financial objectives.

Consider investment time horizon

When considering low-risk investments, it's important to understand your investment time horizon, which is the period of time you expect to hold an investment before needing the money back. This can be a specific date or a more general time period and is largely dictated by your investment goals and strategies. For example, saving for a house down payment in two years would be considered a short-term time horizon, while saving for retirement would be a long-term time horizon. Here are some key points to consider regarding investment time horizons:

Short-Term Investment Horizon

A short-term investment horizon typically refers to investments expected to last fewer than five years. These are suitable for individuals approaching retirement or those who may need a large sum of cash in the near future. Short-term investment options include money market funds, savings accounts, certificates of deposit (CDs), and short-term bonds, which can be easily liquidated for cash.

Medium-Term Investment Horizon

Medium-term investments are those held for three to ten years, such as saving for college, marriage, or a first home. Medium-term investment strategies usually balance between high- and low-risk assets. A mix of stocks and bonds can be a good option to protect your wealth while avoiding significant losses due to inflation.

Long-Term Investment Horizon

The long-term investment horizon is for goals more than ten years away, with retirement savings being the most common example. Long-term investors are typically willing to take on greater risks in exchange for greater potential rewards. The longer time horizon allows for more aggressive investment strategies, as there is a higher chance of recovering from short-term downturns.

Factors Affecting Investment Time Horizon

Your investment time horizon is influenced by your financial goals, risk tolerance, and the type of investment that interests you. It's important to tailor your investment choices to your specific goals, as different goals may have different time horizons. Additionally, the risks you take with your investments depend on the time available for your portfolio to recover from any unforeseen events in the economy or stock market.

Adjusting Your Investment Strategy

As you approach your investment goal, it's crucial to reevaluate your asset allocation. Nearing your time horizon, you may want to consider selling off riskier investments and purchasing lower-risk options to preserve your gains. Target-date funds offered by mutual funds or ETFs can be a hands-off investment choice, as fund managers adjust the asset allocation over time to reduce risk.

Pick the right type of investment account

Picking the right type of investment account is crucial when starting with low-risk investments. Here are some options to consider:

Standard Brokerage Account

A standard brokerage account, also known as a taxable brokerage account or non-retirement account, offers access to a wide range of investments, including stocks, mutual funds, bonds, and exchange-traded funds. Any interest, dividends, or gains on investments are subject to taxes in the year they are received. You can choose between an individual or joint taxable brokerage account, depending on your preferences and goals. It's important to note that a cash account is generally suitable for most investors, while a margin account involves borrowing money from the broker and is better suited for advanced traders.

Retirement Accounts

Retirement accounts, such as traditional and Roth IRAs, are commonly used for long-term investment goals. Traditional IRAs offer tax benefits upfront, while Roth IRAs provide tax-free withdrawals in retirement. It's worth noting that Roth IRAs have income limits, and you should consider your tax bracket when deciding between a traditional and Roth IRA. Additionally, employers often offer 401(k) plans or similar retirement plans, which may include matching contributions.

Investment Accounts for Kids

If you're investing for minors, you can consider custodial brokerage accounts, such as Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts. These accounts allow you to gift money to a child, and the assets are transferred to them when they reach the age of majority. UGMA accounts typically allow contributions of cash, stocks, bonds, and mutual funds, while UTMAs can also hold real estate. It's important to note that the money in these accounts can be used for any purpose and may impact financial aid eligibility.

Education Accounts

Education accounts, such as 529 savings plans and Coverdell Education Savings Accounts (ESAs), are designed to save for education expenses. 529 plans can be used for college or even K-12 education expenses, and the funds can be used for tuition, room and board, books, and technology. ESAs must be set up before the beneficiary turns 18 and can be used for college or elementary and secondary education expenses.

Cash Management Account

A cash management account combines the features of a bank checking or savings account with the flexibility of a brokerage account. It offers check writing, bill payment, a debit card, and investment options. These accounts often provide competitive rates of return and low or no fees, but they don't typically offer tax advantages.

Health Savings Account (HSA)

A Health Savings Account (HSA) is a tax-advantaged savings account designed for eligible individuals with high-deductible health plans. It offers triple tax benefits, including tax-deductible contributions, tax-free withdrawals for qualified medical expenses, and tax-free investment growth. HSA funds can be used for current or future medical expenses and offer flexibility after age 65 for non-medical expenses.

Frequently asked questions