Today we have an article written by Jim Wang, the author of one of the first financial blogs I started reading many years ago (which he later sold for 7 figures). He now shares his knowledge at wallethacks.com.
When I was younger, I thought that if you wanted to invest money it had to be in the stock market.
As I got older, I learned that there are hundreds of options. The stock market is one of the most popular but sometimes you don’t want that volatility. You may want to put your retirement funds in the stock market, since you can wait decades for it to fluctuate (and hopefully fluctuate higher!), but what if you have something you need relatively soon?
That’s why there are safer investment options that don’t promise the same returns but are able to offer less volatility. A savings account is a prime example of something that doesn’t have a high return (high yield savings accounts are offering like 2% as of this writing) but has no risk. You are lagging inflation but it’s 100% safe.
A savings account is great for money you need soon. But what if you have funds in that middle area, perhaps savings for a down payment on a house. You might want a house in three years so the stock market isn’t appropriate, but you don’t really want to have it lose purchasing power in a savings account.
Are there options?
The value of low-risk investments is preserving value. Whether you’re saving for your children, retirement, or a new home, it’s best to have your money parked in safe investment vehicles that offer nominal, risk-free (though sometimes lucrative) gains. The diversification of financial markets has allowed for a storm of risky investments to cloud people’s judgement and give the general impression that only brilliant, sneaky bankers can earn money off leveraged assets. But that’s not true. There are plenty of low-risk, low-cost investment strategies that can make the difference between sleepless nights and hammock naps on Caribbean beaches.
The most common low-risk investments include online savings accounts and CDs (certificate of deposit). There are also different flavors of CDs, like brokered CDs. But you probably know about all those already, I want to share a few that you might not have heard about.
Like savings accounts, savings bonds aren’t usually considered investments as much as “savings instruments.” A savings bonds won’t earn you a ton of interest, but you won’t lose anything and it protects cash against inflation. The Treasury offers two kinds of savings bonds: the EE bond and I bond. The goals of such an investment also come in two: a fixed interest rate return and an adjustable inflation-linked return.
You can earn interest on the EE bond for up to 30 years and, depending on when it was issued, may deliver a fixed rate of return, which usually equates to a 3.5% return on investment. One thing to keep in mind about this kind of bond is that if you try to redeem it before five years has passed, you’ll be penalized the last three months’ interest.
So for short term needs, these aren’t a great option because of the penalty for withdrawal under 5 years. If, however, you want some stability and are willing to give up some interest, this can be a good option.
Money market funds
Money market funds are like a poor man’s diversification plan, as they bundle together CDs and short-term bonds. This is a low-risk, liquid way to invest and you can usually withdraw funds without being penalized. This tool is good for people who do not want to risk their principal investment, as the goal of most money market funds is Net Asset Value (NAV) of $1 per share. You won’t make a ton of money, but you certainly won’t lose any and you can draw upon funds when needed.
The trouble with money market funds is that most of the brick and mortar banks that offer them will give you a pittance in interest. If you move towards online banks, you’ll find better rates but even then it may not be worth the hassle of opening new accounts. Is a fraction of a percent worth the effort? That’s really up to you.
Treasury Inflation Protected Securities (TIPS)
The United States Treasury has a variety of bond-like investment options but the lowest-risk example is a Treasury Inflation Protected Securities (or TIPS). These investments are fairly similar to savings bonds in that there is a fixed interest rate and inflation adjustment is calculated into the bond. You can purchase TIPS individually or as part of a mutual fund.
What makes TIPS useful is that they’re pegged to inflation. Bonds are “risky” because they pay a set interest rate and the value of the bond goes down as the risk free interest rate goes up. If you own a bond that pays you 3% a year and the federal funds rate is at 1%, the value of the bond relies on that 2% difference. If the federal funds rate goes up to 1.5%, then your bond is less valuable because now that difference is only 1.5%.
The face value of the bond doesn’t change but if you wanted to sell it, it would fetch a lower price on the secondary market.
It’s ironic that a local government’s form of a credit card is also a great way to shield your investment from taxation. There has been some exaggeration over the years regarding municipal bonds’ kryptonite-like power against taxes, but the core assertions are correct.
At the federal level, municipal bonds, also known as munis, are typically not taxed. This can be valuable if you’re in a high tax bracket. You have a good chance of getting a tax-free muni at the local or state level too, especially if you live in that municipality.
Munis aren’t without risk because a local government can default on their bonds. It’s very rare but not unheard of. In 2016, Puerto Rico defaulted on general obligation bonds and had to work towards restructuring billions of dollars in debt. In 2013, the city of Detroit filed for bankruptcy – so it’s pretty safe but not 100% so.
Real estate investment trusts (REITs)
Most people are afraid to invest in real estate, either because they think it’s too much work or too risky. But there is a way to invest in real estate that is both safe and lucrative. REITs, real estate investment trusts, are funds that own real estate or real estate companies. REITs are required by law to pay out 90% of their profits so this allows you to buy shares in real estate projects and earn money, a great source of passive income, along with the shareholders.
These are just a handful of the short term, low-risk investment options out there.
There other options to look at, including corporate bonds, ETFs, preferred stocks, P2P lending, annuities, and even credit card bonuses. Ultimately, you need to research the options that fit your financial situation, goals, and risk tolerance.
The goal is to find places to put your money that will earn decent interest, protect it from inflation and taxes, and won’t make you lose sleep from worry. The last thing you want to do is put off buying your dream house because an investment took a wrong turn.
Jim Wang has been writing about personal finance for over 15 years and most recently at Wallet Hacks, where he shares his strategies and tactics for getting ahead financially and in life. If liked this post, you can get more from him by way of a free newsletter and you can sign up for it here!