Which investment type typically carries the least risk?

which investment type typically carries the least risks

Are you wondering which investment type typically carries the least risk? You need to read this.

Of the 61%, 50% admitted they were afraid of losing their money to bad investments.

investment types risks

I call it Fear of risks.

Yes, it’s normal to feel jittery at a time like this.

The economy is down with COVID-19 pandemic, and the stock market is in a coma.

Even Dow Jones Industrial Average (DJIA) lost 18.0 percent, and S&P dropped by 16.5 percent – in one week.

But there are things we can learn from history.

For example, this is not the first time the stock market is going through a difficult time.

It happened in 2018, and it bounced back with a massive return.

In this post, I will be using some historical data and performance charts to show you how to secure your portfolio against future crises and minimize your risks.

Ready? Here we go

1. Diversify your investment portfolio

If you haven’t already, then the first thing you have to do right away is to diversify.

To diversify your investment means to spread it across different asset classes: cash, bonds, and stocks.

With a diversified portfolio, if any of your assets unexpectedly dips, the gains from the other assets will help you offset the loss and secure your investment.

Don’t just take my words for it. Let’s see this:

stocks vs bonds
Blue line: VBMFX (bonds), Red line: VTSMX (stocks). FinancialSamurai

VTSMX (stocks) dipped between 2001 to 2003 and 2007 to 2009.

But it suddenly had a big leap from 2013, while VBMFX (bonds) had steady growths all through 1999 and 2019.

That means 3 things:

Number #1:

If you only invested in VTSMX stocks, your portfolio would drop badly between 2001 to 2003 and 2007 to 2009.

Number #2:

If you only invested in VBMFX bonds, you would earn consistent returns all through– but miss out on the big leap in stocks from 2013.

Number #3:

If you diversified across the two asset classes, you would have the best of the two worlds.

  • The consistent gains from VBMFX bonds would help you offset your loss from VTSMX between 2001 to 2003 and 2007 to 2009.
  • And the big part: your portfolio would take a big leap between 2013 and 2019 when VTSMX eventually jumped and started to outperform the bond.

That’s the wonder of a diversified portfolio.

Diversifying across different assets helps you offset losses and reduce the risks of loosing your investment.

So, how do you diversify?

I will show you in three easy steps:

a. Diversify with Cash Equivalents

Holding a part of your asset in cash secures you against the worst-case scenario.

Especially if you are a beginner, start with cash equivalents assets, then do some research to find the best investment plan for your specific financial goal.

Here’s how:

Savings accounts.

You probably don’t see it as one, but that same savings account in your bank, is the least risky asset you should have in your portfolio.

Since savings accounts are backed by Government insurance, you can still get your money out, even if the bank packs up.

It’s true that savings accounts won’t offer you great returns on your money – but don’t forget: It is there to add some certainty to your portfolio and reduce the risks.

Certificate of deposit.

With a certificate of deposit, you can earn decent returns on your cash holdings – with low risks.

Don’t just take my words for it. Let’s see this:

If you put $10,000 in your CD account with 1.6% APY for 5 years, how much can you expect?

invest in certificate of deposit

$10,826

Pretty decent! Right?

But the good part: It’s a very low risk investment.

b. Diversify with bonds

Spreading your investment across different bond types will help you reduce risks in your bond holdings.

With that, if one particular type of bond sees a downturn, the gains from the other bonds can help you offset the loss and protect your investment.

Government bonds are generally more secure and pose fewer risks than corporate bonds – but they also offer less interest.

A good rule is to at least spread your bond holdings across both corporate and Government bonds.

That way, the corporate bonds in your holdings can ramp up your returns, while your government bonds will help you play down the risks and secure your investment.

c. Diversify with Stocks

You can’t have a balanced investment without stocks.

Even though, stocks are riskier than bonds, they offer much more returns.

But the big part is that stocks and bonds react differently to market changes.

So you need stock possession to secure your portfolio – in case there is an unexpected fall in your bond holdings.

Now talking about risks. There is a freaking easy way to reduce your stock risks. See the next point.

2. Spread your assets across different industries and companies.

Some sectors are worst hit than others when there is a market crisis.

And since you can’t predict the next time the market will go down or which sector will be the worst hit, what you can do is to spread your assets across different industries.

So, if any sector in your portfolio crashes, the gains from the other performing sectors can help you offset the loss and protect your portfolio.

For example, let’s see the performance of stocks across 3 different industries for 10 years using the SP&F stock index.

Number 1: Netflix

Industry: Entertainment and mass media

which carries the least risks

Number #2: Abiomed

Industry: Health technology & Medical services

which investment type typically carries the least risks

Number #3: United Rentals

Industry: Equipment rental services

which investment carries the least risks

Comparing the three cases, you can see that United Rentals’ stocks dipped between 2014 and 2016 – the same time that Abiomeds’ and Netflix’s Stocks had big leaps.

That means 2 things:

  • Those that only had United Rentals’ stocks lost a big part of their returns between 2014 and 2016.
  • But for those that diversified across the three industries, the big gains from Netflix and Abiomed helped them to offset the dip from Abiomed between 2014 and 2016 and ramped up their total return.

3. Screen out junk bonds And Penny Stocks

If you want to challenge a 7 feet tall silverback to a fisticuff, I would probably say good luck.

But there is one thing I will always warn about:

“Don’t ever put your money on junk bonds.”

These are bonds that promise you ridiculously big returns. But those ridiculous offers are not for nothing.

The companies behind these bonds have poor records of defaulting and low trust.

To pull investors, they have to promise ridiculous high coupons. If you fall for them, you can kiss your money a good night.

But how do you know a junk bond?

Here’s a tip:

Check the rating of the company issuing the bond on SP&F here.

A rating of BB or lower means the company is struggling to meet its basic financial obligations and will likely default.

4. Use Proven Investment Vehicles

If you are new to the stock market, you have a lot on your table to sort out:

  • What companies are worth your investments?
  • Which industries are worth your risk?
  • How best can you target your asset distribution to your goal?

You won’t get it right away if you are just starting out. Worse still, you can even screw it up and blow some money away.

There are two things you can do instead:

a. Mutual funds.

Mutual funds give you a basket of securities that are already diversified. So they are designed to reduce risks from your portfolio out of the box.

Also, mutual funds are managed by highly experienced money managers who know how to select stocks and minimize risks.

And the best part:

You can easily talk with your fund manager to know the most suitable funds that will help you hit your financial target and minimize your risks.

b. ETF

ETF is a tradable basket of securities you can buy from a fund provider.

The fund provider owns the assets, designs a diversified fund, and sells part to you in shares.

If you want an already diversified portfolio that you can trade like stocks, you need an ETF instead of mutual funds.

But here is the main point:

Since ETFs are diversified, they help you minimize the risks in your portfolio exactly like mutual funds.

5. Consider a Target Date Fund

A Target-date fund is a smart way to balance your retirement investment between high returns and minimal risks.

Target-date funds work by allocating a large part of your investment to high-yield stocks at the start, then slowly replace them with fixed income assets as you age to reduce your risks.

A good example is the Vanguard Target Retirement 2050 Fund (VFIFX).

At 30: This is what it looks like:

Asset classes% allocated
Stocks90.26%
Bonds9.34%
Others0.4%

At 45: This is what it MAY look like:

Asset classes% allocated
Stocks49.8%
Bonds49.8%
Others0.4%

But isn’t an 85% stock possession too risky to start with? Here it is:

By allocating stocks very early and only slowly replacing them with fixed income assets, a target-date fund gives each stock enough time to recover from occasional market shifts and bounce back with high returns.

Don’t just take my words for it. Let’s see this:

VFIFX performance chart for the last 3 years shows that it’s best 3-Yr total return beat it’s worst 3-Yr total return with a big margin.

which investment type typically carries the least risks

And that’s not all. It has a 5-year average return of 7.71%

6. Address your own specifics

You can look good in Grandpa’s homburg. But when it comes to investment, it’s a new ball game.

You have to design your investment portfolio to your own goal and finances. 

Let’s see this:

A & B are coworkers on the same salary range, both in their thirties.

investment type risks

Now, here is the interesting twist:

Even though both are in their thirties and earn about the same salary, they have different risk tolerance.

Why?

B can’t take the same level of risks in his portfolio as A because he has to consider the impact of his decision on his aged diabetic mom, whom he also supports with a part of his income.

In order words, B has less risk tolerance.

So how do you know your own risk tolerance?

I will help you decide. Please, get a sheet of paper and write down your answers to these four questions:

  • #1: How old am I?
  • #2: Am I new to investment?
  • #3: What is my investment goal?
  • #4: What level of risk can I bear?

Ready? Now, let’s treat the questions one after the other.

a. How old am I?

The younger you are, the better chances you can tolerate risks. The older you are, the less risk you can take.

At 30, even if you make any investment mistakes, you have time to correct it and make better decisions before retirement kicks in.

That means you can tolerate the risks of having more stock holdings than bonds for high returns.

At 45, it’s a different ball game.

You are getting close to your retirement, and you are becoming more risk-averse. So you have to start reducing your stock holdings and adding more fixed-income assets like bonds.

b. Am I new to investment?

If you are a beginner investor, you need more low-risk assets in your portfolio. Then you can move up as you see more gains, and are able to take more risks.

c. What is my goal?

Your goal will help you know what you want with your investment and the kind of risks you can tolerate for that goal.

Now you need to answer two questions:

  • Are you okay with low returns, as far as your principal is secure?
  • Would you consider higher return investments – even if it means risking your capital?

If your answer to the first question is YES, then you need more low-risk assets that yield low but consistent returns.

That means more cash and bonds than stocks.

7. Play The Long Time Game

You have to decide the kind of game you want to play with your investment decision. No, I’m not talking of chess.

Do you just want to buy stocks and sell them fast for quick gains? Then you have one thing to deal with:

A sudden Market change…

Short term or speculative investments have high risks and can easily blow off your money to any sudden market changes.

See this:

long term investment types

Portfolio D, the riskiest of the three portfolios with 85% stock possession, had a 31.91% return in its best 5 years – even beating A, B, C with good margins.

Here’s why:

D has more stock holdings than any of the three portfolios.

Stocks are mostly risky for short-term investments, they generally return much higher yields than bonds – over the years.

That 5 years duration gives Portfolio D with its high stock holdings that enough time to recover from short market disturbances and bounce back with big returns.

Now, I’m not saying it’s time to pack your portfolio with 95% stocks. Jeeeeeez. No.

What I’m saying is this:

Don’t invest in stocks by predicting market changes. Instead, invest for the long-term.

Do that, and your stocks will recover from any short-term losses and rake in massive returns over time.

Final thoughts.

If you were wondering which investment type typically carries the least risk and how to reduce the risks in your portfolio, there you had it.

Have you tried any of these tips?