Low Risk Investments
The term low risk investment has different meanings for people because different people have different perceptions of risk. For example, for some people, an investment which has even a remote chance of a 5% loss over a one-year period is extremely risky, whereas others would only find a remote chance of a 30% to be risk. Indeed, had you invested in stocks in 2007, you would have found that your investment dropped by about 50% over the next year.
Some securities are naturally low risk but very low yield also. For example, money market mutual fund rates are very low, lower than short term bonds for example. Yet the money market funds are so stable that it attracts the highly conservative traders and investors. A synonymous term is known as safe investments.
First, A Few Risky Investments
Let us start by considering some investments that are not safe. It is risky to invest in any single stock as it usually has greater fluctuations than the totality of the stock market. Likewise, investing in the bonds of a country in danger of default is very risky, despite the fact that the stated returns on the bonds are likely to be high. As an example, in mid-2010 during the Greek financial crisis the yields on its bonds rose to greater than 10%, mostly because investors fled the bonds due to fears of default.
Index Funds
Even better low risk investments down the list are the bond mutual funds which are collective investments in many types of bonds. Bond funds come in several types, one of them is taxable versus tax-free. Calculating the yield on bond funds is complicated by this extra consideration. Be sure to check out no load index funds to minimize your fees. Another way to classify bond mutual funds is by the term of the held bonds. Some bond funds only invest in very short term bonds, resulting in lower yields but also lower risk. Some bonds invest in long term bonds with corresponding higher risk and yields. The fund types are independent in that it can be either tax-free or taxable, at the same time be either short, medium or long-term. The best mutual fund companies can give you an idea of what rates to expect.
Bond Funds
What makes bond funds such low risk investments? When an organization or a company needs to raise temporary money, they can do so by issuing these bonds at some specified rate. Very trustworthy companies will have lower rates than dodgy ones. Bond funds are lower risk investments than stocks the repayment depends on a methodical, mutually-supported, orderly repayment strategy. If a bond issuer shows a lack of regard for remaining in the good graces of its investors, then its investors may abandon the fund causing a drop in rates and severe loss of confidence for future bond investments with the issuing company. The loss of confidence translates to the inability to raise money in the future, thereby crippling the operations of the company.
Short Term Vs. Long Term Bond Funds
The bond funds described above come in a short term form and a long term form. The time period short and long describe the qualities of the underlying bond securities in the fund, not how long an investor has to hold on to it. In other words, the investor can just buy and hold the fund as the underlying bond securities continuously turn over. The difference between the two can be summed up in a simple way. The short term bond fund is a safe investment, but has a lower rate of return. The long term bond fund, in contrast, exhibits wiggles and jitters much like the stock market, but has a higher rate of return over long time periods. The time period is on the order of months to years.
Money Market Funds Belong To The Category Of Fairly Safe Investments
Even lower risk than bond funds are the money market deposit account and money market funds. Look up the highest money market rates to get an idea of what to expect. Likewise they are a group-investment instrument that spreads the risk across many money market accounts. Money market funds are actually a bit more subtle. Each individual instrument in the money market fund belong to the category of fairly low risk investments that almost never drop below initial values although the return is expected to vary. Taken as a fund, the money market fund is low risk for both losing its value, and also for growing too slowly as an investment.