Recently, a new client told me that his portfolio mostly contained low-risk investments. When I saw that the majority of his investments were mutual funds, I asked him why he believed mutual funds were “low-risk,” as his funds contained stocks. What he was missing was the mutual funds contained stocks which are risky, so even though the funds were diversified, he was exposed to a lot of risk.
What is a low-risk investment?
An example of a low-risk investment is a bank deposit, or CD (certificate of deposit). A CD pays a fixed interest rate and matures on a specific date. It is “safer” than a stock, the value of which can fluctuate dramatically, since if the CD investor holds the CD until maturity, he knows he’ll get his principal and interest paid in full. Investors looking for a low-risk investment that produces income choose CDs because they pay interest on the original deposit.
Furthermore, CDs are normally insured by the FDIC for up to $250,000 if the bank fails and doesn’t pay back the initial deposit on maturity.
However, though a CD carries a low level of risk, you can still lose money if you sell it before its maturity date. Moreover, if rates of inflation are higher than interest rates, the real value of your money diminishes compared to the original purchase. Additionally, CDs also include an element of liquidity risk, especially if you invest in a long-term CD.
What to think about if you want to invest in CDs
There are many reasons to invest in a CD. It may be worth forfeiting the possibility of higher returns in the stock market for relative peace of mind in preserving your principal.
If so, consider buying CDs through your broker, as CDs purchased through a brokerage account can offer higher returns than if you buy them as an individual through a retail bank.
To learn more about CDs and other low-risk investments, listen to my podcast.
Douglas Goldstein, CFP®, is the Director of Profile Investment Service, Ltd., which specializes in helping people who live in Israel with their US dollar assets and American investment and retirement accounts. He helps olim meet their financial goals through asset allocation, financial planning, and using money managers.
Published July 17, 2017.