Which investment type typically carries the least risk?

When investing, there are so many options to choose from. But it’s really time-consuming, and sometimes frustrating, to figure out which investment type carries the smallest risk of losing money. 

Moreover, it’s hard enough to make money in the first place. The thought of risking it all by investing in something that might not give you a good return is not appealing.

So, I did some research for you!

This blog post compares ten different types of investments, including stocks, bonds, and mutual funds, and breaks down the risks associated with each to find out which investment type carries the least risk for you.

But, before we dive in, it’s really important to understand what investment risk is so you can learn how to mitigate it when investing, and why one of the listed options may be better for your individual circumstances.

And it’s worth knowing that, under certain circumstances, ‘safe’ investment types may not be the financial refuge they appear to be at first glance.

What is investment risk?

Investment risk is the chance that your investment type will not return the amount of money you expect it to. The higher the risk, the greater the chance of this happening.

There are four main types of investment risk to look out for.

  • Market risk. This is the risk that prices in the stock market will go down, causing your investments to lose money and you to lose any capital gains.
  • Interest rate risk. Interest rate risk refers to interest rates rising, which often causes bond prices to fall and impact your portfolio.
  • Credit risk. A company with high credit risk is unlikely to be able to pay its debts, which could lead to losses for investors; and
  • Liquidity risk. Liquidity is how fast your investment asset can be turned into cash. So, the higher the liquidity risk, the harder it is to sell your investment when you want to, or at the price you need.

However, most people don’t mind the risk when making money, only when losing it!

So, it’s usually the downside risk of losing money that’s considered to be investment risk by retail investors, which is why assets that are less likely to lose your money are considered to be ‘safer’.

But, there’s a downside to safer assets – the price you often pay for safety is the opportunity to make bigger returns.

That said, there are options out there that provide a good balance between risk and performance. I’ve included them in the list that follows.

Types of investment risk

Now that you know what investment risk is, and the different types to be aware of, let’s take a look at 10 popular safer investments.

What are low-risk investment types?

1. Savings accounts

A savings account is an account with a bank or credit union that typically pays interest on the money you deposit.

Allegedly, the main benefit of a savings account is that it’s a very low-risk way of keeping your money. In the US, the FDIC insures up to $250,000 per account, and in the UK, the FSCS insures accounts up to £85,000. This means that even if the bank goes out of business, you’re guaranteed to get your money back up to these amounts.

Additionally, savings accounts are easy to open and don’t require a lot of money to get started. You can often find accounts with no minimum balance and no monthly fees.

However, the biggest downside of a savings account is that the interest rate is usually quite low. The average savings account interest rate in the US is currently 0.1%; in the UK, it’s around 1.2%.

That said, some high-yield savings accounts (HYSAs) will be higher, but these often come with conditions, such as having to deposit your money for a certain length of time.

A big risk with savings accounts is inflation. Current annualised inflation for 2022 is forecast at 5.4% in 2022 in the US, and 10.1% in the UK. This means prices are rising in both countries at a faster rate than your money is earning interest.

2. Money market funds

A money market fund (MMF) is a type of mutual fund that invests in short-term debt securities, such as government bonds, certificates of deposit (CDs), commercial paper, and Treasury Bills (T-Bills) in the US.

MMFs are seen as very safe investments because their short-term nature means there’s little chance that the underlying value will fall sharply. This is a much larger risk with longer-term investments.

Additionally, MMFs tend to be very liquid, which means you can cash out your investment at any time without having to pay a penalty.

However, the returns are often similar to bank account returns, so when higher inflation hits, MMFs are not as ‘safe’ as they first appear.

3. Certificate of Deposit (CDs)

A certificate of deposit (CD) is a type of savings account that often pays higher interest than a regular savings account. The main difference between the two is accessibility.

With CDs, you’ll have no access to your money for a certain period of time. I’d argue this increases your liquidity risk if you ever need the money. This is a downside. At least with HYSAs, you’ll likely be able to get access to your money, albeit at the cost of a penalty fee.

On the other hand, the fixed-term nature of CDs means there’s little chance that the underlying value will fall sharply.

However, if inflation is high when you come to cash in your CD, then like bank accounts, you’re money will be worth less in real terms (unless the interest payment keeps up with inflation, which is unlikely).

4. Short-term bonds

Short-term bonds are small packets of debt with only a short time to run before the debt – the bond – is required to be paid back, known as maturity. These bonds usually run between one and three years, but there’s no exact definition; they can run for as long as five. (Check with the issuer or fund manager what they consider to be ‘short-term’.)

The main benefit of these bonds is that they’re safer than long-term bonds because there’s less time for things to go wrong.

However, if interest rates rise, the value of a bond will drop. But, if you hold the bond until it matures, you’ll get back your original investment in addition to any interest payments. With a short-term bond, there’s less time for interest rate movements to change the value of your bond.

Conversely, in an environment where interest rates are going down, bond prices will rise.

Short-term bonds tend to be more liquid than long-term bonds. This means you can cash them in early if you need the money without having to pay a penalty.

Examples of short-term bonds in the US include Treasury Bills (T-Bills), notes and Treasury Inflation-Protected Securities (TIPS). In the UK, these include gilts or inflation-linked bonds (ILBs).

5. Corporate bonds

These bonds are issued by a company to raise money. The company agrees to make regular payments (known as coupons) to the bondholder. It then pays the principal (the face value of the bond) when the bond matures.

Corporate bonds are often seen as being riskier than government bonds. This is because it’s assumed that there’s a greater chance that the company will default on its debt payments than a government – a higher credit risk.

But, it depends on the government and the company you’re comparing! Governments do default on loans (more recently Iceland, Argentina, and Russia…), and many bond-issuing companies are very well run.

However, corporate bonds usually offer higher returns to compensate for this perceived added risk to tempt you away from more paltry government offerings.

6. Low-Risk Alternative Investments

If buying others’ debt isn’t your thing, and you want an alternative choice of investment with relatively low risk, real estate investment trusts (REITs) could be a great option.

A REIT is a type of security that invests in real estate, either through property or mortgages and often trades on major stock exchanges. REITs tend to be less volatile – meaning less risky – than the stock market as a whole and offer high dividend yields due to strict dividend payout requirements.

Fixed annuities are another choice. With a fixed annuity, you give an insurance company money, and in return, they agree to pay you a set amount of income for a certain period of time, potentially for the rest of your life.

Fixed annuities also offer relatively low risk and high dividend yields. And, unlike stocks or mutual funds, the principal investment is almost always guaranteed by the issuing insurance company.

Commodities such as gold and other precious metals that retain their value can also be a good source of relatively low-risk investment when financial markets are volatile. However, there may be storage and insurance costs involved with these investments, so make sure you do your homework!

7. Peer-to-Peer Lending

P2P lending is a type of investing that involves loaning money to individuals or businesses through online platforms, such as Zopa. With the advance in digital platforms, it’s become a popular way to potentially earn higher returns than you would from a bank without taking on too much additional risk.

But, and this is a big but, you need to use a reputable platform with a large reserve fund that is able to reimburse you should your borrower default, and choose your borrower with care. Also note that these schemes are often not covered by the FSCS (UK), or FDIC (US).

Lower-Risk Ways To Invest In Stocks

Investing in stocks is considered to be a more risky way to invest than in bonds or cash because of the volatility involved with stock market prices. Big declines in a share price can lose you money, but the higher peaks also provide opportunities to make better gains.

However, there are still ways to invest in stocks that can lower your risk; this is where the next section of investment comes into play.

7. Exchange Traded Funds (ETFs)

Investing in an ETF is one way to diversify your portfolio and lower your risk.

An ETF is a type of security that tracks an index, such as the S&P 500 or the FTSE 100. They trade on the stock market like any other share.

They are made up of a mix of assets and are not actively managed by a fund manager, which keeps your costs down. There are ETFs available for markets all over the world. Some ETFs will track sectors, such as energy, and some may track bond markets, for example. The variety available is simply mind-blowing.

ETFs are one of my favourite ways of investing.

8. Mutual Funds

Another way of investing in stocks with lower risk is to invest in a mutual fund.

Like an ETF, a mutual fund is a pooled investment where money is collated from many different investors and then invested in a mix of assets, such as stocks and bonds.

However, unlike an ETF, a mutual fund is actively managed by a professional fund manager. This often increases costs to the investor, but a good fund manager will add additional value.

Each fund is unique and is designed with a specific investment objective in mind, so it’s always a good idea to thoroughly read the prospectus.

9. Dividend-paying stocks

Personally, this is one of my favourite methods of lower-risk stock investing.

Dividend-paying stocks are shares in a company that pays regular dividends to shareholders. This is very similar to receiving coupons on a bond.

However, unlike bonds, companies usually only pay dividends if they are profitable, and dividend payments can vary from year to year. A long dividend history is often a sign of a well-run company which helps when deciding which company to invest in.

The downside of investing in dividend-paying stocks is you lose portfolio diversification which is considered to be riskier. But, a solid dividend from a well-run company can help your portfolio to offset share price drops and rising inflation.

10. Utility stocks

Utility stocks are shares of companies that provide necessary services like water, electricity, and gas. We always need utilities, so share prices in these companies tend to be relatively stable. And, often, they offer high dividend yields as well.

However, utility firms are often tightly regulated by governments, which impacts how these companies do business. Sometimes, this limits a company’s ability to raise prices when its costs are increasing, which reduces profits and share price performance.

Personally, I’d stick to investing in the larger well-known providers with big pockets – oil and gas price increases in 2021/22 have put many smaller utility suppliers out of business.

Pros and Cons of Low-Risk Investments

So, in summary:

Pros

  • Low-risk investments have lower volatility, decreasing uncertainty.
  • They often provide income (dividends or interest payments).
  • They are a great way to balance an investment portfolio.

Cons

  • The returns are often lower than with higher-risk investments.
  • Inflation can eat into your investment over time (although some low-risk investments, such as dividend stocks, can help with this).
  • Some low-risk investments have low liquidity as you can’t always access your money as quickly as you want to.

Remember: being overly cautious is risky

In times of rising inflation, often putting all your money into ‘safer’ investment options is not actually safe at all, as inflation steals the value of your cash.

So, it pays to take some risk because not taking any is far riskier.

The key is to take a portfolio approach to your investing, balancing lower-risk investments with those of higher risk.

Putting all your money into a bank account is a recipe for financial gloom, although it’s not always immediately obvious as the stated amount in your account doesn’t change. But its real-world value does.

Low-Risk Investment Type or a High-Risk One?

By investing in a mix of asset classes, geographies, and sectors, you spread your risk. This means that if one area underperforms, another may stem any losses.

A low-risk investment type is a great option if:

  • The thought of investment risk concerns you, but you want to start investing;
  • You already have higher-risk investments in your portfolio and want to add something to help offset potential losses; and
  • You have an emergency fund and want to make your money work harder.

Low-risk investments are less useful when:

  • Your investing strategy is short-term, e.g. day trading.
  • You’re prepared to lose the money you’ve invested; or
  • You are an experienced investor and want to gamble.

The Bottom Line: Which investment type typically carries the least risk?

Frankly, no single investment type carries the least risk. Risk is mitigated by asset diversification as part of a holistic portfolio approach to investing.

Investing money, even if you’re only saving it in a bank account, carries a level of risk. But not investing money also carries risk! The risks change continually with the macroeconomic environment.

Many so-called low-risk investments depend on low-interest-rate environments to make money. When inflation strikes, it may make sense to take on board some higher-risk investments to ensure your portfolio as a whole is low-risk.

Do you have any of these investment types in your portfolio?

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