You’ve worked hard to earn your money, and now it’s time to let it work for you. Investing is a savvy way to increase your net worth by essentially doing nothing. Create a solid investment strategy now, so you’ll be set for the future.
It’s important to be careful with your money, even when focusing on low-risk investments. There’s no such thing as an investment with no risk, so you really need to research where you put your money. Whether you’re trying to save money for retirement, purchase a home or send your children to college, learning how to invest money wisely can help you reach your goal a little faster.
5 Tips for Low-Risk Investing
1. How to Decide How Much to Invest
The right amount of money to invest differs for everyone. To figure out what’s right for you, define your investment goals, determine how long you can go without accessing the funds and decide how much — if any — of your money you can afford to risk.
First, you need to set a specific goal so you can give your investment a timeline. Your objective could be a variety of things, such as saving for a new car, your child’s education or your own retirement.
Next, it’s time to decide if the investment is short-term, mid-term or long-term. As a general rule, short-term investments are around 18 months or less, mid-term are two to five years and long-term are five years or more.
Finally, you’ll want to determine if you can afford to risk any of your principal. The amount of risk you’re willing to take will be factored in with your goals and timeline to create an investment portfolio positioned to meet your objectives.
2. Diversify Your Assets
Even the safest investments come with a risk, but you can decrease it by diversifying your portfolio. Distributing your funds between different types of investments helps you avoid systemic risk (which impacts the economy as a whole) and non-systemic risk (which affects a small portion of the economy or one company in your portfolio).
Create an asset allocation strategy where you include different types of investments in your profile, such as stocks, bonds, cash and real estate. This increases the probability that at least some of your investments will offer good returns if others lose value or prove to be stagnant.
Additionally, it’s wise to diversify your investments in each category, rather than putting all bets on one investment. This variety offers an added sense of security that you won’t lose all your money if one specific venture doesn’t pan out.
3. Focus on Tactical Asset Allocation
So how much should you invest in each category? There are two strategies. A tactical asset allocation strategy calls for investing an array of percentages in every asset class, meaning you can increase your distribution in a particular category when the stocks are expected to perform well and decrease it when they’re projected to perform poorly. Conversely, strategic allocation is a buy and hold strategy. You set initial targets and intermittently rebalance your portfolio as returns alter original asset allocation percentages or your targets change.
According to The New York Times, investment professionals traditionally followed a 60/40 approach to building a portfolio — 60 percent allocation to stocks, 40 percent to bonds. But tactical asset allocation is now often seen as more proactive. For example, if bonds currently are overpriced and stocks are underpriced, you would increase the amount of stocks and decrease the percentage of bonds in your portfolio to capitalize on this trend. If the market changes in six months, you’d rebalance your portfolio.
4. Try to Beat Inflation
Since 2010, inflation rates in the United States have varied from a high of 3.2 percent in 2011 to a low of 1.5 percent in 2013. After accounting for inflation, there’s a one-in-three chance that you won’t get your investment back with a cash savings account, reports Betterment, because nominal cash interest rates have recently been averaging around 1 percent or less.
If you’re putting aside money for a long-term goal, such as retirement or your young child’s future college education, strive for a 30 percent buffer over the original target to keep up with inflation.
5. Don’t Frequently Monitor Returns
It’s only natural to want to keep a close watch on your portfolio, but doing so can cause you to lose money, according to Betterment. If you’re monitoring your returns on a daily, weekly or monthly basis, there’s a pretty good chance you’re going to see a loss. Obviously, this will be alarming and it could ultimately cause you to make a poor decision to reallocate your assets, hindering your overall performance.
Do your best to resist temptation and only check your portfolio once per quarter. Constantly checking in does nothing besides cause you stress and put your financial future in jeopardy.
5 Low-Risk Investment Strategies
1. Treasury Inflation Protected Securities (TIPS)
TIPS are fixed-income securities issued by the U.S. government. These investments are unique because they’re designed to keep pace with the Consumer Price Index (CPI). Standard fixed-income investments come with the risk that the purchasing power of your interest payments could be decreased over time due to inflation.
Unlike traditional bonds, TIPS pay the greater of the inflation-adjusted or original balance at maturity, making it an essentially risk-free investment. Of course, the drawback is that if interest rates rise, you won’t get higher payments with TIPS. This type of investment is a great way to beat inflation and to diversify your portfolio.
You can purchase TIPS directly as individual bonds through the U.S. Treasury, a broker or through a mutual fund. The cheapest route is to buy them directly from the U.S. Treasury, but if you’re trying to create a fully diversified fixed-income portfolio, a mutual fund might be a better choice.
2. Certificates of Deposit (CDs)
A CD is a deposit account that often offers a higher interest rate than a traditional savings account. For example, top paying one-year CDs currently offer 1.20% or more. You’re required to invest a certain amount of money for a specified period of time, such as six months or five years, in exchange for the promise of an interest rate that is locked in until maturity.
When your CD matures, you receive your original investment, plus any accrued interest. If you decide to withdraw your funds early, you may have to pay a penalty fee or lose some of the interest you earned.
You can get a CD through most credit unions, banks or brokers. This is a great choice for a low-risk investment, because you’re guaranteed to get your principal deposit of up to $250,000 back, as long as you invest in an FDIC-insured institution.
Cash vehicles, such as CDs, are great for short-term investments. If you’re saving for a specific financial goal, such as buying a new car next year, this is a savvy way to get a little bit closer to your goal.
3. Dividend-Paying Stocks
When you invest in a dividend-paying stock, you get paid just for owning the stock. Most companies pay dividends four times per year. For example, if you owned 1,000 shares of a stock that paid $0.20 per share, you would receive a check for $200 each quarter.
Total dividend growth is estimated at 8.2 percent over the next year, according to a March 2015 FactSet report. Digging a little deeper, the financials and industrials sectors are projected to rise 12.8 percent and 10 percent, respectively. Companies that pay dividends are typically stable, and their stock prices tend to be secure, often making them a lower risk than ones that don’t pay dividends.
Dividend rates are not guaranteed, but companies enjoy having a reputation of delivering attractive dividends, so they work hard to satisfy investors. This low-risk investment can be a great way to reach short- and long-term goals. Dividend-paying stocks can be purchased directly from the company or through a broker.
4. Municipal Bonds
A municipal bond is a debt obligation issued by states, cities, counties and other government agencies to fund public projects like highway repairs and hospital construction. In most cases, the interest on municipal bonds is exempt from federal income tax. If you live in the state where the bond was issued, the interest might also be exempt from state and local taxes.
Municipal bonds provide a consistent stream of interest payments, but rates are typically lower than those attached to taxable fixed-income securities. This type of investment is a great choice if you’re more interested in protecting your assets, rather than realizing significant returns.
The most common types of municipal bonds are general obligation bonds and revenue bonds. General obligation bonds are backed by the “full faith and credit” of the issuer, meaning it has the power to tax residents to re-pay the obligation. Revenue bonds are backed by the proceeds of the project instead of the government.
Municipal bonds can serve as a smart way to diversify your portfolio. This low-risk investment can be used to hedge higher-risk ventures into the stock market. You can find municipal bonds using the Electronic Municipal Market Access (EMMA).
5. Real Estate
Become a landlord. Freddie Mac notes that rents increased an average of 3.6 percent in 2014 and almost 11 percent over the past three years. And more than a third of Americans rent, according to the U.S. Census Bureau.
Borrowers with good credit can find 30-year, fixed mortgage rates at an APR of 3% to 4%. Prepare to put a down payment of at least 20 percent on your first property, but you can use the equity to purchase other rental properties.
If you decide to purchase a property and live there for a while, Fannie Mae’s First Look program can help you get started. The program allows first-time homebuyers to negotiate and purchase a property owned by Fannie Mae for at least the first 20 days it’s on the market, before investors are allowed to bid. You can be eligible for this program if you move into the property as your principal residence within 60 days of closing and live there for at least a year.
It’s up to you whether you’d prefer to buy a multi-unit complex through First Look and become a landlord immediately and purchase a single-family home, live in it for a year and then rent it out.
Real estate is a great way to diversify your portfolio and beat inflation. Real estate investments have outperformed equities and fixed income regularly over the past five-, 10- and 20-year periods on an annualized basis. Enjoy inflation protection by increasing rent for inflation annually when leases expire or adding annual increases into your rental agreements.