Investing Risks: Highs And Lows To Consider For Success

Risk is an important aspect of investing. While the concept of risk-reward is well-known, suggesting that higher-risk investments yield higher returns, the notion of risk in investing is not well-defined and is difficult to measure. Generally, a high-risk investment is one with a large chance of loss of capital or underperformance, or a high chance of a devastating loss. Conversely, a low-risk investment has a small chance of losing some or all of your money and usually yields lower returns. Low-risk investments include US Treasury securities, money market accounts, and dividend-paying stocks. High-risk investments include stocks, individual stocks or bonds, and biotechnology stocks.

High-yield savings accounts

Pros:

• High-yield savings accounts offer a higher rate of return on your deposits compared to traditional savings accounts. This means your money will grow faster.
• They are generally safer than investing in the stock market, bonds, or cryptocurrencies because your money is insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) up to $250,000 per depositor.
• Most high-yield savings accounts are offered by online banks, which have lower overhead costs than traditional banks. This allows them to offer higher interest rates and no monthly fees.
• You can withdraw and transfer funds without any penalties, giving you easy access to your money.
• They are a good option for short-term savings goals, such as saving for a new car, vacation, or a down payment on a home.

Cons:

• Interest rates on high-yield savings accounts are variable and can change at any time, so the rate advertised may not last forever.
• They may not be the best option for long-term wealth generation as the interest rates may not keep up with inflation.
• Some accounts have minimum balance requirements or caps on the maximum amount that can earn the advertised interest rate.
• There may be limits on the number of withdrawals or transfers you can make each month, and not all online banks offer ATM cards.
• Most high-yield savings accounts are offered by online-only financial institutions, so if you prefer in-person banking, this could be a drawback.

Overall, high-yield savings accounts are a great option for those seeking a safe and flexible way to grow their money with competitive interest rates. However, it's important to consider the potential drawbacks and shop around for an account that suits your needs.

Money market funds

However, money market funds are not insured by the Federal Deposit Insurance Corporation (FDIC). Instead, they may be eligible for $500,000 in coverage under the Securities Investor Protection Corporation (SIPC) when held in a brokerage account.

While money market funds are considered very low-risk, they are not entirely risk-free. There have been rare instances, such as during severe financial crises, where money market funds "broke the buck", meaning their value dropped below the target of $1 per share, leading to losses for investors.

Compared to other investment options, money market funds have low returns. They generate income but little to no capital appreciation. This can result in a loss of purchasing power if the rate of inflation is higher than the fund's return. Additionally, expenses and fees can eat into profits, making it difficult for investors to keep up with inflation.

In summary, money market funds are a low-risk investment option that offers stable, short-term returns. They are ideal for investors seeking a safe place to park cash in the short term or those looking to diversify their portfolio. However, it's important to consider the lack of FDIC insurance and the potential impact of low returns and fees on overall profits.

Short-term certificates of deposit

CDs are available at banks, credit unions, and brokerages, with terms ranging from 3 months to 10 years. The best CD rates are usually higher than savings accounts, but you lose withdrawal flexibility. If you withdraw your funds early, you will be charged a penalty.

CDs are a good option if you have cash that you don't need immediately but will want within a few years. They are also a good choice if you want to invest some of your savings more conservatively, with lower risk and volatility than stocks and bonds.

When considering a CD, it is important to shop around and compare rates and terms. Typically, the longer the term, the higher the interest rate. However, if interest rates are expected to rise, shorter-term CDs may be more favourable as you won't be locked into a lower rate for an extended period.

While CDs offer a stable and secure investment option, it is important to be aware of the potential drawbacks. In addition to the lack of flexibility with withdrawals, CDs may also earn less than stocks and bonds over time. Furthermore, if interest rates rise during the term of your CD, you may be missing out on higher returns from other investment options. Lastly, inflation can erode the value of money locked in at a fixed rate.

Overall, short-term certificates of deposit are a low-risk investment option that can provide a stable return, making them suitable for those seeking a short-term, secure investment.

Cash management accounts

CMAs usually offer higher interest rates than typical bank savings accounts, and the interest earned is taxable. They also provide passive income streams that can be reinvested in the financial markets or used for short- and intermediate-term cash needs. Funds in CMAs are insured by the Federal Deposit Insurance Corporation (FDIC) or the Securities Investor Protection Corporation (SIPC), which ensures that cash is safe up to legal insurance limits.

• Higher interest rates: CMAs generally offer higher interest rates than typical bank savings accounts, resulting in greater cash flow.
• Passive income: CMAs earn interest, providing a passive income stream that can be reinvested or used for short-term and intermediate cash needs.
• FDIC and SIPC insurance: CMAs are insured by the FDIC or SIPC, protecting your cash up to certain limits. For example, the FDIC insures cash up to $250,000 per depositor per bank, while the SIPC covers the value of investments and cash up to $500,000, including $250,000 for cash.
• Debit card and bill pay: Many CMAs offer a debit card with ATM access, enabling individuals to make purchases, withdraw cash, and pay bills easily.
• Overdraft protection: Some CMAs provide overdraft protection, helping individuals manage their finances effectively.
• Easy transfers: CMAs facilitate easy transfers between investment and cash accounts, allowing individuals to invest or spend their money seamlessly.
• Mobile check deposit: CMAs often include mobile check deposit functionality, providing convenience and flexibility in depositing checks.

However, it is important to consider some potential drawbacks of CMAs:

• Online-only access: Many CMAs are offered by institutions that exist only online, so individuals who prefer in-person banking may not find them suitable.
• Minimum balances: Some CMAs require high minimum balances or regular deposits to access all the features offered.
• Interest rate variability: CMA interest rates vary with market rates and can fluctuate, impacting the returns on deposited funds.
• Withdrawal limits: CMAs may impose limits on withdrawals, affecting liquidity and access to funds.
• Monthly fees: Certain CMAs charge monthly management fees, which can offset the benefits of higher interest rates.

Overall, cash management accounts can be a convenient option for individuals looking to streamline their financial accounts and potentially earn higher interest rates on their deposits. However, it is essential to carefully consider the features, fees, and limitations of different CMAs before choosing one that aligns with your financial needs and goals.

U.S. Treasury securities

Types of U.S. Treasury Securities

Treasury securities are of two types: marketable and non-marketable.

Marketable Treasury Securities

• Treasury Bills (T-bills): Zero-coupon bonds with maturities of one year or less, commonly issued for 4, 8, 13, 17, 26, or 52 weeks. They are sold at a discount and redeemed at face value, with the difference calculated as taxable interest income.
• Treasury Notes (T-notes): Maturities ranging from 2 to 10 years, with interest paid semi-annually. Ordinary T-notes have a fixed interest rate set at auction, while floating-rate notes pay interest based on rates from periodic auctions of 13-week T-bills.
• Treasury Bonds (T-bonds): These have the longest maturities, ranging from 20 to 30 years, and pay interest semi-annually.
• Treasury Inflation-Protected Securities (TIPS): These have maturities of 5, 10, or 30 years, and their principal amount adjusts based on the consumer price index. Interest is paid semi-annually, and at maturity, investors receive the greater amount between the inflation-adjusted principal and the original principal.

Non-Marketable Securities

• Savings Bonds: These are non-marketable and can be redeemed only by the original purchaser or beneficiary in case of death. They are offered as Series EE and Series I bonds, with the former guaranteeing to pay at least double the purchase price at 20 years, and the latter having a variable interest rate based on inflation.
• State and Local Government Series (SLGS): These are purchased by government entities below the federal level with excess cash obtained from tax-exempt bond sales.
• Government Account Series: The principal form of intragovernmental debt holdings, issued to federal departments and entities like the Federal Deposit Insurance Corporation.

Risk Profile of U.S. Treasury Securities

Treasury securities are considered low-risk investments due to their backing by the full faith and credit of the U.S. government. This means that the government promises to raise funds by any legally available means to repay investors. While the U.S. could technically default as a sovereign power, its strong record of repayment makes this highly unlikely.

However, it is important to note that Treasury securities are still subject to some risks, including interest rate risk, inflation risk, and credit or default risk. For example, during periods of deflation, Treasury Inflation-Protected Securities (TIPS) may experience a loss of principal. Additionally, investors should monitor current events, national debt levels, Treasury yields, credit ratings, and the strength of the dollar to assess the risk of default.

Advantages of U.S. Treasury Securities

Treasury securities offer several advantages, including tax advantages, liquidity, and a wide range of maturities.

Tax Advantages

Interest income from Treasury securities is exempt from state and local income taxes, although it is subject to federal income taxes.

Liquidity

Treasury securities are considered highly liquid due to the active secondary market for outstanding Treasuries.

Range of Maturities

Treasury securities cater to diverse investment horizons, with maturities ranging from 4 weeks to 30 years.

Disadvantages of U.S. Treasury Securities

Despite their low-risk nature, Treasury securities also have some drawbacks, including lower yields compared to other investments and the potential for capital gains taxes.

Lower Yields

Treasury securities typically offer lower yields than other fixed-income securities due to their low-risk nature.

Capital Gains Taxes

Treasury notes and bonds purchased at a discount may be subject to capital gains taxes when sold or redeemed.

In conclusion, U.S. Treasury securities offer a relatively safe and stable investment option, particularly suitable for those seeking low-risk assets. While they carry minimal risk due to their government backing, investors should still be mindful of potential risks and disadvantages associated with this investment class.

Frequently asked questions