Low Risk Investment Vehicles Offer Safety and Peace of Mind
For most of us, saving for retirement during our working years is necessary to allow us to retire at 65 without having to spend the remainder of our life struggling bitterly to make ends meet. Old age can bring a whole new set of needs and expenses, and believing that we will be able to survive on little to nothing just because we’re old and no longer gainfully employed is a dangerous fallacy.
So, like it or not, we’re forced to play the investment game while we can. So what is one to do if one hates the idea of putting ones hard earned cash out there were it may be obliterated by the rapid ups and downs of a volatile economy?
While all investments come with a certain amount of risk, there are those that are considered safer than others. And low-risk investing doesn’t have to entail buying gold doubloons and hiding them on a remote island.
Examples of low-risk investments
Naturally, experts will argue regarding the exact risk assessment of each possible investment, but most of them agree that the categories listed below include a broad selection of comparatively low-risk options.
When you purchase a bond from the government, you are in essence lending the government money. The government promises to pay you back at a certain date, with interest.
Of course, the risk-assesment of a government bond will depend on which government that is issuing and guaranteeing the bond. A government bond issued by the United States government will typically be seen as lower risk than a government bond issued by the Nigerian government.
Government bonds can be issued and guaranteed by federal entities, state entities, municipal entities and similar.
Sometimes, government bonds comes with favorable tax treatment to make them more appealing to the investors.
T-Bills (United States)
In the United States, a Treasury Bill (commonly referred to as T-Bill) is a short-term debt obligation backed by the U.S. government. The maturity is less than one year, and some T-Bills have a lifespan of just a few days. The most frequently utilized lifespans are one month, three months and six months. The longer the lifespan, the higher the interest rate. T-Bills are considered a very low-risk way of earning a guaranteed return.
At the time of writing, T-Bills are sold in denominations of $1,000 and it is possible to purchase just one T-Bill if you want to. Having a lot of money to invest is therefore not necessary. In general, income from T-Bills are exempt from both state and local income taxes, but aren’t exempt from federal income taxes.
Money Market Funds (United States)
A Money Market Fund is an open-end mutual fund that invest in short-term (less than 1 year) securities representing high-quality, liquid debt and monetary instruments. The objective is to earn interest for the shareholders while also maintaining a net asset value (NAV) of $1 per share. Until 2014, Money Market Funds were allowed to fix their net asset value at $1 but new rules imposed by the U.S. Securities and Exchange Commission have forced fund managers to utilize a floating NAV instead of the fixed $1 NAV. The new 2014 regulation has also placed tighter restrictions on portfolio holdings.
Money Market Funds will typically invest in Treasury Bills (T-Bills), Certificate of Deposits and Corporate Commercial Paper. Preservation of capital is more important that trying to achieve high income distributions. Investing in Money Market Funds will typically mean modest income distributions coming your way. Money Market Funds are characterized by low-risk, low-return. It’s a highly liquid investment.
Unlike many other mutual funds, Money Market Funds typically have no loads. (Mutual fund load = a fee charged for entering or exiting the fund.)
Money Market Funds are not covered by U.S. federal deposit insurance. If you want U.S. federal deposit insurance, you need to go with things such as deposit accounts and certificate of deposits instead.
Money Market Funds are regulated under the Investment Company Act of 1940.
Cash (physical cash and cash in a bank account)
Money in bank accounts typically falls into two categories, depending in the nature of the account: money that you can withdraw freely at anytime without penalty and money that have various withdrawal restrictions placed on them. Every low-risk nest egg should include liquid cash that can be utilized without penalty. In addition to this, you may also want to look into bank accounts where the money cannot be withdrawn without a penalty, but where you are paid a favorable interest rate as compensation. One needs to carefully weigh the pros and cons between the various bank accounts before deciding how to allocate available funds. There are also certain pros and cons associated with keeping actual physical cash, e.g. in a safe or in a safe deposit box.
Having currency available that is accepted locally (either local currency or a major currency such as USD or EUR) will provide you with cash in case of an emergency. High-interest emergency loans can have a serious negative impact on an individual’s net worth and credit rating. Also, you don’t want to end up in a situation where you feel compelled to conduct a “fire-sale” of other investments just to produce cash. Always have a part of your nest egg in cash to make it possible to borrow money from yourself in case of a serious emergency.
Since there is always the risk of inflation or hyperinflation, one might prefer to own more than one currency – especially if we are talking about a fairly large amount of cash.
Cash, especially bills, are susceptible to damage, e.g. due to fires and floods, and they are also highly sought after by criminals. If one decides to own a large amount of cash, one must factor risks such as these into the risk-assesment.
As far as bank accounts go, there is always the risk of a bank failing to meet its obligations to its depositors. In the United States, a large selection of bank accounts are available with federal deposit insurance, up to a certain amount. Most other countries employ similar guarantees and governmental insurance policies to safeguard the public’s faith in the banking system and prevent bank runs.
If a bank fails, you can expect your funds to be tied up for a while until the federal deposit insurance policy (or the equivalent) starts paying out.
Certificate of Deposit
Certificates of Deposits are issued by banks and by savings and loans entities. The lifespan of a Certificate of Deposit (CD) is typically at least three months, and some CD:s does not mature until they are six years old.
Certificates of Deposit often pay a somewhat higher interest rate than other super low-risk investments. They do however charge a penalty for early withdrawal. In essence, you are paid a higher interest rate because you pledge to not make any withdrawals during the lifespan of the CD. It is perfectly legal to break this pledge and make an early withdrawal, but you can expect the penalty to be quite hefty. Always check how penalties are determined before you invest in Certificates of Deposits.
In the United States, Certificates of Deposit are covered by federal depositors insurance.
Banker’s Acceptances are short-term credit instruments created by an individual or company (the drawer) and guaranteed by a commercial bank. They are considered negotiable instruments with feature of a time draft.
Banker’s acceptances are commonly used in commercial transactions, typically with a lifespan ranging from 30 days to 180 days from the date of issue. On the date specified on the banker’s acceptance, the issuer (drawer) of a bank acceptance is obliged to pay the bearer of the banker’s acceptance the amount noted on the face of the banker’s acceptance.
Banker’s acceptances are traded at a discount from face value on the secondary market. This makes it possible for the bearer of a banker’s acceptance to avoid waiting for the instrument to mature.
Since a banker’s acceptance is guaranteed by a commercial bank, the risk assessment is made based on the creditworthiness of the bank and not on the creditworthiness of the issuer (drawer).