When it comes to investing, there is always a trade-off between safety and return. The safest investments offer low risk and protection of your principal investment, but usually come with lower returns. Investments with higher returns tend to have higher volatility and greater risk. Ultimately, the "safest" investment with the "highest" return will depend on your individual risk tolerance and investment timeline.
In general, the safest investments with the potential for higher returns than a regular savings account are FDIC-insured certificates of deposit (CDs), money market accounts, Treasury securities, investment-grade municipal and corporate bonds, and dividend-paying stocks. Exchange-traded funds that track major indexes are another option which offers market returns with lower volatility. For truly passive income, real estate investment trusts allow you to invest in rental properties and cash flow without the landlord duties. More speculative investments like penny stocks, junk bonds, emerging markets, and cryptocurrencies may generate high returns but have substantial risk of losing money.
This article will analyze the pros and cons of various low- to medium-risk investment vehicles and strategies. We'll explore how factors like investment time horizon, risk appetite, tax considerations, and economic conditions affect the relative safety and returns of different investments. The goal is to educate investors on striking the optimal balance of safety and return for their unique investment objectives and constraints. Ultimately there is no one-size-fits-all "best" or "safest" investment, but rather an appropriate allocation across various assets based on the investor's needs and profile.
Savings Accounts
Savings accounts are a basic deposit product offered by banks and credit unions that pay interest on the account balance. They are considered one of the safest places to put your money. Here's an overview of key features:
Since savings accounts are backed by the FDIC/NCUA and pay stable (albeit low) interest rates, they are one of the safest places to put your money if you are risk-averse and prioritize the preservation of your principal. However, the returns are modest compared to investment products.
Money Market Accounts
Money market accounts are a type of savings account that generally earns higher interest rates than a regular savings account, making them one of the safest investments with the potential for higher returns.
Overview
A money market account is a special type of savings account offered by banks and credit unions. It functions like a regular savings account, allowing you to deposit and withdraw money, but usually pays a higher interest rate. The interest rates on money market accounts fluctuate based on current market conditions but on average earn more interest than regular savings accounts.
Money market accounts are considered very low risk investments. They are FDIC insured up to $250,000 per depositor, per bank just like regular savings accounts at banks. This makes them an extremely safe place to put your money while earning a return.
Interest Rates
Interest rates on money market accounts currently average around 0.15% APY across banks but rates can fluctuate widely depending on market conditions. Generally money market accounts offer anywhere from 2 to 20 times the interest rates of a standard savings account.
The interest rates on money market accounts are variable and will increase when the Federal Reserve raises rates. This differs from CDs which lock in a fixed rate for a set period of time. Money market rates are closely tied to short-term interest rates.
When shopping for the best rates, online banks typically offer the highest APYs on money market accounts right now. Credit unions also usually offer more competitive rates than brick-and-mortar banks.
Risks
Money market accounts are considered extremely low risk investments. They are insured by the FDIC so your principal up to $250,000 is protected against loss. As cash investments, they do not fluctuate in value like stocks and bonds.
However, money market account interest rates can fluctuate over time. Current rates are very low, so you may not keep pace with inflation. You could potentially earn higher returns over the long run with other investments like stocks, but would take on more risk.
The main risks are opportunity cost of earning lower returns than other investments, and inflation outpacing the interest you earn on your money market funds.
Certificates of Deposit (CDs)
Certificates of deposit, also known as CDs, are low-risk investments offered by banks and credit unions. They are time-bound deposit accounts that have fixed interest rates and terms.
CDs are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. This makes them very safe investments. You are guaranteed to get your principal back as well as the stated interest rate when the CD matures.
Interest rates on CDs are usually higher than rates on savings and checking accounts, but lower than rates on other securities like stocks and bonds. Rates vary based on the term length. Short-term CDs of under 6 months have lower rates, while 5-year CDs generally have the highest rates. The national average rates are around 0.10% for 3-month CDs and 0.60% for 5-year CDs.
CD terms can range from 1 month to 5 years. The longer the term, the higher the interest rate since your money is tied up for longer. Short-term CDs are more liquid, but long-term CDs give you higher returns.
Overall, CDs are a very safe investment that guarantees your principal. The interest rates are fixed so you know exactly what return you'll get if you hold the CD to maturity. They are best suited for short-term savings goals of 1-5 years where you want no risk of losing principal. The main drawback is tying your money up for a set period of time and getting lower returns than investing in the stock market.
Treasury Securities
Treasury securities, commonly referred to as "Treasuries", are debt obligations issued and backed by the U.S. government. They are considered one of the safest investments available, since they carry the full faith and credit backing of the U.S. government.
There are three main types of Treasury securities:
The interest rates on Treasuries are considered a benchmark for overall interest rates in the U.S. economy. The yields on Treasuries move inverse to their prices. When demand rises, prices go up and yields go down.
Treasuries carry very low risk as they are backed by the full faith and credit of the U.S. government. However, they can still lose value with rising interest rates. The longer the maturity, the higher the interest rate sensitivity.
Overall, Treasury securities offer stability and safety for fixed income investors. They provide moderate returns in exchange for low risk and protection against volatility. Adding Treasuries can be a prudent way to balance riskier assets in an investment portfolio.
Municipal Bonds
Municipal bonds (or "munis") are debt securities issued by state and local governments as well as other governmental entities to raise capital for public works projects or other needs. They are attractive to some investors because they offer certain tax advantages.
Municipal bonds are considered relatively low-risk investments. They are backed by the credit and taxing power of the issuing jurisdiction rather than the assets or credit of a company. Additionally, municipal governments have access to tax revenues that enable them to repay bondholders.
The interest income earned on municipal bonds is generally exempt from federal taxes and may also be exempt from state and local taxes if you reside in the state where the bond is issued. This tax exemption allows munis to pay lower interest rates than taxable bonds of similar maturity and credit quality. For investors in higher tax brackets, the tax-exempt status gives munis an advantage over other bonds like corporate bonds.
The interest rates paid on municipal bonds vary based on factors like the bond maturity date, credit rating, and supply and demand. Long-term municipal bonds typically pay higher interest rates than short-term bonds to compensate investors for tying up their money for longer. Highly rated bonds considered very safe also pay lower rates than bonds with lower credit ratings. When demand for munis is high, interest rates tend to fall.
While municipal bonds have lower historical default rates than corporate bonds, they still carry risks like interest rate risk, reinvestment risk, call risk, credit risk, and inflation risk. Investors should consider their risk tolerance and investment time horizon when deciding if municipal bonds fit their portfolio.
Municipal bonds can provide attractive tax-free income, especially for those in higher tax brackets. However, they require thorough research to assess risks and align with investment goals.
Dividend Stocks
Dividend stocks are stocks that pay out regular dividends to shareholders. They can offer a stable source of income along with potential appreciation in the stock price over time. Dividend stocks tend to be more mature, established companies that generate consistent profits.
Some key things to know about dividend stocks:
Dividend stocks offer a compelling option for investors seeking recurring income along with growth potential. Focusing on high quality companies with stable earnings and commitment to maintaining dividends can provide an attractive long-term investment choice. Proper diversification is key to manage risks inherent in equities.
Index Funds
Index funds are mutual funds or exchange-traded funds (ETFs) that track a market index, such as the S&P 500. They aim to match the returns of the index by investing in the same securities at the same weights as the index.
Index funds provide instant diversification, as they hold hundreds or thousands of stocks from a variety of companies and sectors. This diversification helps reduce risks compared to investing in individual stocks.
Over long periods, index funds historically have returns comparable to the overall stock market. For example, the S&P 500 has returned about 10% annually over decades. Index funds that track the S&P 500 provide a simple way to earn these long-term stock market returns.
However, index funds still carry risks like any other investment. When the stock market declines, index funds decline in value too. The diversification does not protect against overall market downturns.
Investors should have a long-term perspective when investing in index funds, as the potential for higher returns comes with higher short-term volatility. Time in the market is generally more important than timing the market.
Overall, index funds offer a low-cost, diversified, and effective way to invest for the long run. The simplicity appeals to many investors who don't want to continuously research and pick individual stocks.
Real Estate Investment Trusts (REITs)
Real estate investment trusts (REITs) are companies that own or finance income-producing real estate across a range of property sectors. REITs provide investors with an attractive way to gain exposure to real estate as an asset class.
Some of the benefits of investing in REITs include:
Some risks to consider with REIT investing:
Overall, adding REITs to a balanced portfolio in moderation can provide stable dividend income, diversification, long-term growth potential, and exposure to physical real estate without the direct costs and management. Investors should research individual REITs carefully however, as performance can vary significantly across the diverse REIT sector.
Conclusion: Summary of Safest Options, Highest Returns, and Final Recommendations
When looking for the safest investments with the highest returns, there are a few key options that generally rise to the top. Here's a quick summary of some of the lowest-risk investments that can still provide healthy returns:
Savings Accounts
Savings accounts are extremely low-risk and ideal for emergency funds or other short-term savings goals. The returns are modest, usually between 0.5-2% APY, but savings accounts are FDIC insured and offer easy access to your money.
CDs
CDs lock up your money for a set period of time in exchange for a higher interest rate. 1-year CDs often pay about 1% APY while 5-year CDs can pay closer to 2-3% APY. CDs are FDIC insured up to $250,000 per depositor per bank.
Treasury Securities
Treasury securities like T-bills, notes, and bonds are backed by the full faith and credit of the U.S. government so they are considered extremely safe. Returns range from about 1-4% depending on the term.
Municipal Bonds
Municipal bonds are issued by local governments to fund public projects. They're generally low risk and pay 1.5-3% in tax-free interest income.
Index Funds
Index funds provide instant diversification and long-term returns around 7-10% per year historically. The broad stock market is volatile in the short-term but has generated solid returns over decades.
Dividend Stocks
Some stocks pay steady dividend income in addition to potential growth. Focus on stable, blue-chip companies that have paid dividends for decades. Target a 3-4% dividend yield.
In summary, savings accounts, CDs, Treasury securities, municipal bonds, index funds, and dividend stocks generally represent the safest investments that can still provide respectable returns of 3-7% per year. Maintain a balanced portfolio, invest for the long-term, and consistently contribute to take advantage of compounding returns.
