Investing is all about balancing risk and return. The riskier a security, the more investors demand to be paid for holding it.
It’s important to hold riskier investments, such as growth stocks, to outpace inflation. However, there’s also a place for vehicles with lower risk, which help maintain portfolio stability. That can be especially valuable during market downturns, or for short-term cash needs.
[Sign up for stock news with our Invested newsletter.]
Here are some low-risk investments that can serve as portfolio ballast:
— Certificates of deposit.
— High-yield savings accounts.
— Treasury bonds.
— Treasury inflation-protected securities.
— Preferred stock.
— Investment-grade corporate bonds.
— Municipal bonds.
Certificates of Deposit
Certificates of deposit, or CDs, are fixed-term, low-risk savings instruments with guaranteed interest rates.
“CDs are perfect for low-risk investors who don’t need access to their cash until a specific future date, like an upcoming tax bill or a home renovation,” says Seth Kritzman, a chartered financial analyst, or CFA, who is a senior fixed income analyst at Greenleaf Trust in Birmingham, Michigan.
With a fixed interest rate, he adds, savers know exactly what they’ll earn. A CD is also insured up to $250,000 by either the Federal Deposit Insurance Corp. or the National Credit Union Administration.
“However, a downside of CDs is that they lack liquidity. If you end up needing your money early, you’ll typically face penalties for early withdrawal,” Kritzman adds.
High-Yield Savings Accounts
As the name suggests, these accounts offer a higher interest payment than a regular savings account, along with the low levels of risk you’d expect when you stash money away as savings.
“High-yield savings accounts are an excellent option for investing your money because there is little to no risk of losing your investment,” says Annette Harris, owner of Harris Financial Coaching in Jacksonville, Florida.
She adds that many accounts today offer rates exceeding 4%, which can be higher than the current rates of certificates of deposit.
“It’s important to note that many banks offering high interest rates are digital-only institutions. If you anticipate needing quick access to your cash, consider keeping some of your funds in a local bank,” Harris says.
Treasury Bonds
A Treasury bond is a debt issued by the U.S. government with a term of 20 to 30 years.
“Treasury bonds are a reliable way to grow your savings for future retirement goals or financial planning,” Harris says. “They are considered a safe investment with minimal risk and fixed interest rates that remain constant throughout the investment period.”
An investor who buys a Treasury bond receives interest payments twice a year. At the end of the term, the buyer also gets the principal back.
“However, it’s important to note that the interest rate is locked in once you purchase a bond,” Harris adds. “If interest rates rise after your purchase, you will not benefit from the new, higher rates.”
In addition, Harris says, Treasury owners must pay federal taxes on the interest earned.
Treasury Inflation-Protected Securities
Treasury inflation-protected securities, or TIPS, are debt instruments issued by the U.S. government with an unusual twist: Their principal adjusts with inflation, so the value of the debt better reflects rising prices.
“Inflation is typically the most significant danger to a retiree’s portfolio,” says Matt Hylland, a financial advisor at Arnold and Mote Wealth Management in Hiawatha, Iowa.
“Over a 20- or 30-year retirement, even modest inflation can eat away at the purchasing power of your savings,” Hylland says. “TIPS offer a great way to ensure your savings maintain their purchasing power, while also receiving a U.S. government guarantee.”
However, he notes that TIPS can still have significant interest rate risk. If interest rates rise, investors may see TIPS’ value temporarily drop.
“This became very apparent for investors in 2022, who were surprised to see the value of their TIPS funds decline as inflation went higher,” he adds. Although TIPS match inflation over the long run, many investors cash out because they don’t understand how these instruments work.
Inflation protection doesn’t equate to protection against a decline due to rising interest rates.
“Because of this interest rate risk, matching your needs with the maturity of TIPS is extra important,” Hylland says. “If you need money in 2026, don’t use a long-term TIPS fund.”
Preferred Stock
Preferred shares are equity securities, but they have characteristics of fixed income. Owners receive fixed dividends and priority over holders of common stock if the company liquidates. In exchange for this preferred treatment, shareholders have limited voting rights.
“Preferred stocks pay a coupon like a traditional bond, but they don’t necessarily have a maturity date,” says Christopher Robbins, a CFA who’s a principal at Bartlett Wealth Management in Cincinnati.
They can be an attractive option for income-focused investors, he adds, because they often pay a higher yield than corporate bonds.
However, he notes that preferred shares have some added risks. For example, because they tend to have higher interest rate sensitivity than traditional bonds, large rate increases may lead to significant price declines.
“Without a set maturity date, investors can get stuck with losses on their preferred stock positions when this happens,” Robbins says.
In addition, many preferred shares are callable, meaning the issuer can buy them back from holders at a pre-determined price. That can be a good thing when a holding is called away at a price higher than the investor paid.
However, investors may be forced to part with their preferred stock at a lower price than they paid because they neglected to understand the call provision.
Investment-Grade Corporate Bonds
These are bonds issued by companies deemed by bond raters to have a low risk of default. They’re more risky than Treasurys, but less risky than high-yield bonds, issued by companies with lower creditworthiness.
Investment-grade corporate bonds are currently yielding 0.8% more than U.S. Treasury bonds of the same maturity on average, Robbins says.
“The extra yield is enticing, but investors need to know that this yield premium is much lower than it has been on average over the last 20 years,” he says. Historically, he adds, investment-grade corporate bonds have yielded 1.55% more than Treasurys of the same maturity.
“Today’s smaller yield advantage is an indication that investors aren’t terribly worried about the credit quality of corporate bond issuers,” Robbins says.
Municipal Bonds
Investors in high tax brackets often turn to municipal bonds, which offer tax-free income.
“State-specific munis offer the benefit of double tax exemptions: No federal or state taxes on the interest earned,” Kritzman says.
However, he points out, these bonds often have lower yields due to high demand, so they’re typically only beneficial to residents of the issuing state.
“If you’re in a state with lower taxes, diversifying across various states can actually boost your after-tax returns,” he says. “Purchasing munis from states without income tax, which typically have higher yields to compensate for lower local demand, can be advantageous even after paying your own state’s taxes.”
Munis are particularly beneficial, Kritzman adds, for investors who are confident they won’t need the funds before maturity.
“Liquidity can be an issue, meaning selling before maturity might require accepting a lower price,” he says.
For those in high tax brackets, Kritzman says, it’s crucial to ensure munis are tax-exempt and not subject to the alternative minimum tax.
More from U.S. News
5 of the Best Investment Websites for Beginners
6 of the Best Companies to Invest in for 2025
8 Best Investments for a Trump Presidency
7 High-Return, Low-Risk Investments for Retirees originally appeared on usnews.com
Update 12/30/24: This story was previously published at an earlier date and has been updated with new information.
