How Can I Manage Investment Risk with Fixed-Income Investments?
Any kind of investment will come with a certain degree of risk. When you build an investment portfolio, you want to ensure that you’re making choices that don’t endanger the stability of your finances.
To help protect yourself from unpredictable losses and instabilities, consider fixed-income investments. In general, they deliver a return on a regular schedule. And if you choose investments that are relatively low in risk, you can make reliable predictions about the amounts you’ll earn.
The following are five types of fixed-income investments you should consider if you want to avoid high levels of risk and receive fairly dependable returns.
Certificate of Deposit
With a Certificate of Deposit (CD), you open a special account at a bank and place a certain amount of money in it. The money will stay in the account for months or years and earn interest at a fixed rate within that time period. Once the term length is over, you can take your initial deposit plus the interest you’ve earned out of the CD or you can allow the money to roll over or renew for another term.
What are the potential advantages of a CD?
First, you’ll be able to receive larger interest payments than you would from money deposited in a checking account or regular savings account.
Second, if you choose a reputable bank that’s insured by the Federal Deposit Insurance Corporation, you’ll receive certain protections in the event that the bank collapses. At each FDIC-insured bank, the amount of money protected for a single depositor is $250,000.
Finally, there are a variety of different CDs for you to choose from, so you can pick the best one for your needs. These include one that allows you to prematurely withdraw money without a penalty and another that gives you the option of bumping up the interest rate in the middle of the term length.
The main downside is that the interest rates may be low and don’t keep up with inflation, meaning that your money could lose purchasing power over time. Generally, CDs that are set for a longer-term length have higher interest rates. However, if you suddenly need the money, you’ll typically pay a penalty to withdraw it from the account before the term is over.
Money Market Fund
Money market funds are known for their low volatility. Like other mutual funds, they combine money from a large number of investors and partake in a variety of investments. However, in contrast to funds that invest in stocks or other riskier vehicles, money market funds rely on investments that have a lower risk as these investments must meet relatively high credit standards.
The types of investments vary depending on the money market fund. For example, some heavily invest in bonds and other securities from the U.S. Treasury. The earnings from certain funds may also be exempt from taxes at a state or federal level. Make sure to check if that exemption applies to you.
As with other low-risk investments, the main drawback is that the returns you receive may not keep up with inflation. But you can tackle this issue by making informed choices about the kind of money market fund you invest in, how you intend to use it, and the portion of your money that will go into it.
High-Yield Savings Account
At an FDIC-insured bank, you may be able to open a high-yield savings account that gives you a more favorable interest rate than you’d receive from a typical savings account. The FDIC protection helps make it one of the safest investment choices.
In contrast to a typical CD, a high-yield savings account will give you access to your money without penalties, although there are generally limits to how many times you can withdraw from the account each month. When opening an account, be sure to carefully review its requirements and rules, including minimum balance.
Another possibility is to open a money market account, which may have higher interest rates than a high-yield savings account while usually demanding a larger minimum balance. Keep in mind that a money market account isn’t a money market fund, although the similar names lead to confusion. You can open a money market account at a bank and it’s insured by the FDIC. A money market fund doesn’t enjoy that kind of protection.
Treasury Inflation-Protected Securities
This investment is similar to a Treasury bond. Therefore, you can expect to receive interest payments for it a couple of times a year at a fixed rate.
The primary difference with TIPS is that its face value adjusts with inflation. The value may actually go up, meaning that you could receive larger interest payments along the way and a greater amount of money on the maturity date.
What happens if the country experiences deflation? On the maturity date, the payment you receive won’t fall below the original face value. Even if there’s deflation, that amount won’t decrease.
It’s a good idea to check out the bonds and other securities offered by the Treasury. Because they’re backed by the U.S. government, they’re considered a low-risk option for investment. Compare their interest rates, maturities, and other dimensions to make a more informed choice.
Fixed Annuity
A fixed annuity is comparable in some ways to a CD. However, instead of making the arrangement with a bank, you set it up with an insurance company.
One of the benefits of a fixed annuity is that the interest you gain from it remains untaxed until it’s time for you to access the money. In contrast, your earnings from a CD are always taxable. Another benefit is that fixed annuities are resilient in the face of wild and potentially unfavorable activity in the stock market.
When you’re considering an annuity, keep the following in mind:
- Make a thorough review of the details. These include fees, expected returns, and how the annuity might be adjusted for inflation over time.
- Check the reputation of the insurance company you’re working with and whether you’re given any protection if the company folds.
- Remain alert for scams, and resist salespeople who try to pressure you into quickly signing a contract. An annuity may not be an optimal choice for you, and you shouldn’t rush this important decision.
Selecting the Right Investments
Before investing your money, it’s important to consider several factors, including the following:
- Your retirement plans and how close you are to retirement.
- Your income from other sources, such as your job or any property you’re renting out.
- Your budget and how much access you need to the money you plan to invest.
To protect yourself from steep losses, thoroughly research your options, and make sure that the bulk of your investment portfolio is relatively safe. Even if you want to set aside a little money for an individual stock that you think looks promising, most of your money shouldn’t be exposed to high-risk investments. When chosen wisely, fixed-income investments can become a key part of your financial stability and long-term growth.