Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He and his wife are "empty nesters" living in New Hampshire.
The stock market continues to trade at record levels, so who should be worried about low risk investments? Well, you should! And so should anyone heavily invested in stocks.
Record stock prices might be emotionally comforting to investors, but they’re also the starting point of virtually all crashes. That’s because crashes can only take place when valuations are hyperextended.
That’s why low risk investment options are always needed to shore up your investment portfolio. And not just at market peaks either.
Low risk investments add stability to your portfolio. Should stocks experience a major decline, your low risk investment allocation will reduce your losses.
But perhaps even more important as a long-term investment strategy is that low risk investments will provide you with the cash needed to buy stocks after correction, a prolonged bear market, or even a crash.
It’s sometimes referred to as ‘keeping your powder dry’, and it can have a huge impact on your long-term investment success.
Another important point: In today's ultra-low interest rate environment it's no longer possible to get totally safe, high yield investments in one place.
A strategy is needed in which you mix lower yielding, but totally safe investments, with higher yielding ones with low or moderate risk.
The idea is to increase your income without taking on too much risk. It is possible.
Summary of the best low-risk investments
My 3 Favorite Low Risk Investments
Let's face it, finding a low risk investment opportunity with high return is really rare. The ones that most people find are just too good to be true and end up becoming a scam or ponzi scheme.
Not the case with the list. It only includes tried and proven low-risk investments that you can take to the bank, no matter what type of economy that we are in.
I figure that I would share my top 3 favorites to get us started.
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High-Yield Savings Accounts
These are a no brainer way to collect extra money, without doing any additional work. Most people store their money in a checking account, why not put it in one of these puppies and earn interest off your hard earn money. My favorite right now is a Betterment.
With that said, there are plenty of low risk investments available. Let’s look at an even dozen of them:
1. High-yield savings accounts
According to the FDIC’s Weekly National Rates and Rate Caps report, the average yield on savings accounts nationwide is a paltry 0.9%.
Not only is that an insult to savers, but it won’t even keep you even with inflation. Since inflation is running closer to 2% per year, you’re losing money every year you leave your money sitting in a low yield savings account.
Fortunately, there are online savings accounts that pay much higher yields. Since they’re provided by banks that operate either largely or entirely online, they don’t have the overhead that comes with maintaining a network of bank branches and a large staff necessary to man them.
Examples of banks offering high-yield savings accounts include:
- CIT Bank Savings Builder. With an initial investment of just $100, followed by regular monthly contributions of $100 or more, you can earn 2.20% APY on your money.
- Marcus by Goldman Sachs. Their Online Savings Account currently pays 2.00% APY with no minimum deposit requirement.
- Discover Online Savings. The account offers interest payments of 1.90% APY on a minimum balance of $15,000.
You don’t have to end your relationship with your current bank. But you can keep just enough funds in your local bank savings account to cover immediate needs, while keeping the largest amount in an online high-yield savings account.
Deposit Minimum: $0
2. Money market accounts
The rate situation is very similar with money market accounts. While local banks and even brokerage major firms pay some fraction of 1% on their money market funds, there are online banks offering MMAs that pay many times higher.
They’re a perfect place to park cash that you’re saving for a specific goal, like the down payment on a new car or an upcoming vacation.
You can earn higher interest with safety of principal. Each of the banks listed in the previous section also have high-yield money market accounts available.
But some additional online banks worth checking out include:
- BBVA USA, currently paying 2.00% APY on balances of $10,000 or more
- UFB Direct’s Premium Money Market fund is currently paying 2.15% APY on balances of $25,000 or more.
- Capital One’s 360 Money Market currently pays 2.00% APY on balances of $10,000 or more.
As you can see, the major difference between money market accounts and savings accounts is that money markets typically require higher balances to get higher interest rates.
But if you have the extra cash to invest, it’s worth opening an account. A money market account works similar to a high interest checking account, except that you aren’t able to access your money quite as frequently.
3. Certificates of Deposit (CDs)
CDs work well for holding money for intermediate savings purposes. For example, let’s say you’re saving money for the down payment on a house – or to pay for a wedding – in two or three years.
CD's are an excellent way to lock in the highest current interest rates for the entire term you need to hold the money. The ability to lock in interest rates on intermediate savings has become more important with the recent trend toward declining interest rates.
You can lock in a CD interest rate at 2. something percent for as much time you need to hold the savings. And once you do, there’s zero risk of getting a lower return on your money.
Not coincidentally, the same banks that offer high-yield savings accounts and money market accounts also provide high-yield CDs.
But additional banks worth considering include the following:
- Ally Bank is currently paying interest rate yield of 2.50% APY on their five-year CDs. This is especially important because the yield on longer-term investments in general have fallen with the onset of the inverted yield curve.
- Citi is currently paying a rate of 2.00% APY on their 12-month CDs. They do require a minimum initial investment of $25,000.
- Citizens Access has some of the best CD rates across the board. They currently pay 2.25% APY on their 18-month CDs, and 2.45% on their five-year CDs. They require a minimum initial investment of just $5,000 to participate.
4. Dividend paying stocks
The current average dividend yield on the S&P 500 index is 1.87%. That makes large-company stocks competitive with interest rates being paid on US Treasuries, and well ahead of most local banks.
But you can get even better dividend yields on high quality stocks. A popular website known as Sure Dividend keep a running report of what are known as Dividend Aristocrats.
These are large-company stocks that not only have a long history of paying above average dividends, but also of increasing them on a regular basis.
The website currently reports 57 stocks included in that list. You can invest in the stocks individually through a brokerage account with a major investment firm.
But if you prefer to invest in a fund, you can go with one that specializes in dividend aristocrats. An example is the ProShares S&P Dividend Aristocrat ETF. It has a current dividend yield of 2.51%.
One other benefit of high dividend stocks is that, unlike true fixed income investments, they also offer the opportunity for capital appreciation.
If the stock market continues to rise, or if the financial fortunes of the dividend paying companies continue to improve, the value of the underlying stock will rise while you’re earning a healthy dividend.
But you should also be aware that stocks that offer dividend payments are more risky than true fixed annuity income investments.
Just as stock prices can rise, they can also fall. Think of them as being more of a moderate risk investment that a pure low risk one.
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5. Peer-to-peer (P2P) lending
With this category we’re moving away from pure low risk investments, to one that provides a higher return with higher risk. P2P lending platforms have sprung up across the Internet, in which investors can fund loans made to consumers.
It’s basically a process in which borrower and lender come together, but without the bank operating as an intermediary. As an investor, you’ll be able to select individual loans to invest in.
Loans are graded by platforms, ranging from A for the highest rated loans, to C and D for lower rated loans. Naturally the higher rated loans pay lower interest rates.
The rate range can be anywhere from about six percent to as high as 36%. The idea is to blend a mix of higher and lower grade loans to provide a balance of safety and high-yield.
These investments are referred to as “notes". With a total investment of just $1,000, you can spread your money across 40 different loans.
But once again we have to emphasize these are higher risk investments. The loans are completely unsecured, and can default. If they do, you’ll lose your principal, as well as future interest income.
Loan terms run from three years to five years, so your money will be tied up for that term. P2P investments are best used as a minority slice of the investment allocation in your portfolio.
A 10% or 20% slice of your income allocation can raise your overall interest income, without dramatically increasing your risk. But don’t get carried away, because they’re not completely safe investments.
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6. Real estate investment trusts
Real estate investment trusts, more commonly known as REITs, are something like mutual funds that hold real estate. They mostly concentrate on the large properties, including office buildings, shopping centers, large apartment complexes, industrial facilities, warehouse space, and other property types.
They give small investors an opportunity to invest money in large commercial real estate projects, once reserved only for the wealthy and for institutional investors.
Overall, the long-term performance of REITs has been equal to or even slightly better than the performance on the S&P 500 index.
They’re becoming increasingly popular among investors and even robo-advisors, not only because of high yields, but also because they add an alternative investment component to a portfolio.
Real estate is, after all, a “hard asset”. It even has the potential to perform well when the financial markets are wobbling. REITs are legally required to return at least 90% of their net income to their shareholders as distributions.
What’s more, since real estate involves depreciation, some of the income received may be tax-free. And in addition to the income from dividend distributions, there can be capital appreciation from the sale of the underlying properties.
According to the FTSE Nareit All REITs Index, the current yield on REITs is 3.97%. And that doesn’t include the capital appreciation the funds offer.
REITs can be an excellent way to increase the income generated in your portfolio, while also adding real estate to your investment mix.
They’re not totally risk free, but they tend to have more stable values than stocks. And like dividend paying stocks, they add the potential for capital appreciation to regular dividend income.
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7. Preferred Stocks
Preferred stocks are a special class of stock because in that they have a higher claim on dividend distributions than common stocks do.
Simply put, it means there’s a greater level of assurance you’ll receive dividends on preferred stock than on common stock. They also typically pay higher dividend yields than common stock.
Preferred stocks usually come with a set dividend level at the time of issuance. Alternatively, the yield may be set to match a certain common index, like the LIBOR.
While the company may or may not pay dividends on common stock, depending on company performance, they will pay preferred stock dividends except under extreme circumstances.
In addition, in the event the company is liquidated, preferred stockholders will be paid ahead of common stockholders.
In a way, preferred stock is something of a hybrid between common stock and corporate bonds. Once again, preferred stocks can be purchased either individually through popular investment brokerage firms, or through funds.
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8. Fixed interest rate annuities
These are a different kind of interest-bearing investment, because they’re actually investment contracts you hold through an insurance company.
This means they’re unlike CDs, government securities, or stocks, in that they cannot be redeemed at will. You’re basically turning a certain amount of money over to the insurance company, in exchange for a regular stream of income.
Fixed rate annuities are best suited for retirees looking to create a long-term income source to supplement Social Security, pensions, and other retirement income streams.
If fact, they can be a good option if you don’t have a pension. Fixed rate annuities come in two flavors, deferred and immediate.
With a deferred fixed rate annuity, you invest money in the contract, and it grows until you begin taking distributions. In between, the income will accumulate on a tax-deferred basis, similar to an IRA.
Under intermediate fixed rate annuities, your investment with the insurance company will begin paying interest income as soon as the annuity is established.
You can open a fixed rate annuity with as little as $1,000, with an agreed-upon interest rate that will be fixed throughout the term.
The annuity term itself can run for either a certain number of years, or even for the rest of your life. Interest rates depend on the specific annuity you’re taking, including the terms established.
There are negatives associated with fixed rate annuities however. You will pay an annual fee that will reduce your income.
There are surrender charges that can be as high as 8%, if you choose to liquidate the annuity within the first few years. And unless you make special provisions, the annuity principal will revert to the insurance company upon your death.
9. U.S. treasury securities
US government Treasury securities are generally considered to be the safest investments in the world. Unlike savings accounts, money markets and CDs, they’re not FDIC insured.
But they have an even higher level of protection, being backed by the full faith credit and taxing power of the US government.
The yields aren’t quite as high as they are for bank savings products, due to that higher level of safety. But they’re totally liquid, and you can invest in them for as little as $25.
And you can buy, hold, and sell them on the Treasury Department’s investment portal, Treasury Direct. But be aware that they no longer issue paper certificates as evidence of ownership.
However, you can access your account in the portal at any time. Current yields on US Treasury securities are at the following levels:
- One-year Treasury bill, 1.88%
- Two-year Treasury note, 1.79%
- Five-year Treasury note, 1.75%
- 10-year Treasury note, 1.90%
- 30-year Treasury bond, 2.37%
Do you notice that the one-year bill is paying more than the five-year note, at 1.88% versus 1.75%? That’s the inverted yield curve I was talking about earlier.
It’s when shorter-term interest rates are higher than those on longer term securities. It’s a fairly unusual phenomenon, and doesn’t usually last very long. But it’s something to be aware of.
10. Municipal bonds
Municipal bonds are debt securities issued by state and local governments. They have a special advantage of being tax-free for federal income tax purposes.
But if you purchase municipal bonds issued by the state you live in, they’re also free from your state income tax. That makes them double tax-free.
If you have a combined federal and state marginal income tax rate of 30%, a municipal bond with an interest rate yield of 1.75% would be the equivalent of getting 2.50% on a taxable interest-bearing investment.
Because of their tax-exempt status, municipal bonds are best held in taxable investment accounts. There will be no tax benefit to holding them in a retirement account, since those accounts provide for tax-deferred investment income already.
You can buy individual municipal bond issues through popular investment brokerage accounts, like eToro, Webull or Interactive Brokers. But to diversify your holdings, it’s often better to purchase municipal bond ETFs.
They enable you to invest in a portfolio of municipal bonds, rather than tying your money up in just one or two. According to a recent report by Kiplinger, some of the best municipal bond ETFs include the following:
- iShares National Muni Bond ETF (MUB) holds more than 2,000 individual municipal bond issues, and has a current yield of 2.2%.
- Pimco Intermediate Municipal Bond Active ETF (MUNI) has a current yield of 2.00%.
- VanEck Vectors Short High-Yield Municipal ETF (SHYD) has an interest yield in excess of 3.00%. The fund obtains higher rates by investing in lower quality bond issues. That means this fund is riskier than the others.
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11. Investment grade corporate bonds
According to the Federal Reserve the current yield on investment grade corporate bonds is 3.87%. (Investment grade is considered a rating of Bbb or Baa, or better.)
These rates are much higher than what you can get on bank savings vehicles, US Treasuries, or municipal bonds, because they are issued by individual corporations and considered higher risk.
You can invest in individual issues of corporate bonds through popular investment brokerage accounts. But for smaller investors, it will be better to do it through funds, like either ETFs or mutual funds.
Just as is the case with municipal bonds, investing through funds will give you an opportunity to diversify a small investment across many different bond issues.
You can investigate which funds offer the best blend of safety and interest rate return. But also carefully consider the average term of bonds held in any fund.
The longer the average term of the bonds held, the greater the risk that rising interest rates will cause the principal value of the bonds to drop, causing you to lose money on the investment.
If you do invest in investment grade corporate bonds, be careful not to confuse them high-yield bonds. Once commonly referred to as “junk bonds”, they pay higher yields than investment grade bonds because they’re lower quality, and more likely to default.
They are securities rated less than BBB or BAA.
12. Pay off debt
One of the best low risk investments you can make – and one you probably don’t think of as an investment at all – is simply to pay off debt.
Eliminating a 10% interest rate on a debt is the equivalent of earning 10% on the same amount of money held in an investment. For example, let’s say you’re paying 20% per year on a $10,000 credit card balance.
Since there’s no investment that will offer anything close to a fixed 20% return, paying off the credit card will be far superior to investing the same amount of money in a low risk investment.
It may not be possible to pay off large debts quickly, such as student loans or your home mortgage. But credit cards should certainly be a priority, because of the high interest rates they charge.
Next would be installment loans on furniture or entertainment equipment, followed by auto loans. And if you can pay off your home mortgage, you’ll be locking in an interest rate comparable to the one you’re paying on your mortgage on a permanent basis.
What Low Risk Investments Will You Try?
As you can see from this list, there are plenty of low risk investments paying much higher returns than you can get at your local bank.
But just be aware that certain investments fall into the no risk category, like bank investments and short-term US Treasuries, while others – like corporate and municipal bonds as well as longer-term US Treasuries – do carry slightly more risk.
But if you’re willing to take on moderate risk to get higher than average returns, you can opt for dividend stocks, investment grade bonds, and real estate investment trusts.
And if you want still higher returns – and you’re willing to take on even more risk – you can put at least some of your money into P2P lending.
Finally, if you’re looking for a long-term stable income stream – with no risk – there are fixed rate annuities. But just be aware that if interest rates rise significantly after you enter your annuity contract, you’ll be stuck with a lower rate on a permanent basis.
The best strategy is to mix up your fixed income portfolio a bit. This can be done by adding three or four of the investments listed in this article.
For example, you might create an income portfolio allocation that looks like this:
- 50% in bank assets
- 25% in dividend stocks
- 15% in a real estate investment trust
- 10% in P2P loans
That isn’t any kind of commonly recognized scientific asset allocation, but just an example of what you can do.
The basic point is to find the right balance of return and safety for your income portfolio. It’s more important than ever in the low interest rate environment we’re in right now.
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