Many of us are holding a great deal of cash. The question is what do we do with it? If we go all-in on the stock market and it tanks we take serious losses. On the other hand, if we have a major correction, we have the cash needed to buy some great stocks at a discount. This is why I’m only investing at a rate of $2000/month. I’m holding some cash, saving money, and expect to be fully invested in 3-4 years. Unfortunately, cash holdings are losing around 2-3% a year to inflation. To combat these losses I compiled a list of some low risk investments…
Certificate of Deposit (CDs)
A CD is a savings certificate with a maturity date and a fixed interest rate. Principle is tied up until this maturity date. These investment vehicles offer low risk as they are FDIC insured up to $250,000 per individual. Unfortunately, with low risk comes low return. Because interest rates are low most CDs are offering rates between 1-3% depending on the maturity date. Short term rates are effectively less than inflation making CDs a losing investment.
Money Market Funds
A money market fund is a type of mutual fund offering low risk low returns. They typically invest in municipal securities, CDs, and T-bills. Money markets are highly liquid and are almost like holding cash. Unlike CDs, savings accounts, and money market deposit accounts; they are not FDIC insured. Again, we’re looking at rates similar to that of CDs (1-2%).
A bond is a form of debt where an investor loans an entity money in exchange for interest. The entity could be a company, municipality, or sovereign government. These entities use the principle to fund various projects. Bond holders are often called debtholders or creditors. The entity is referred to as the issuer. In terms of risk, bonds typically carry more risk than CDs and less risk than stocks. On the corporate hierarchy, creditors get paid before shareholders. A bond’s issue price is set at “par”. For example, this could be $1000. The market price is then determined by the issuer’s credit quality, time until expiration, and coupon payment. If the coupon payment is 5% the creditor will receive $50 annually. The creditor then receives the “face value” when the bond matures. Bonds are just as complex, if not more so than stocks. Fully explaining bonds would probably take me starting an entirely new blog. However, firms like Fidelity, Vanguard, and PIMCO offer a wide variety of bond mutual funds. They have exposure from municipals to higher risk “junk” bonds and typically hold thousands of different bonds in their portfolios. They also do a great job educating investors and explaining exactly how these funds work.
Treasury Inflation Protected Securities
TIPS are a form of bonds offered by the U.S. Treasury. They come in two forms. One offers a fixed rate that doesn’t change for the duration of the bonds. The 2nd form has built in inflation protection. Whatever rate inflation grows during the time you hold the bond, your investment will rise with that inflation rate. TIPS can be invested in individually or through a mutual fund. Like most securities, TIPS can be purchased through online brokers like Ally Invest, E Trade, and TD Ameritrade.
I mentioned P2P lending a few posts ago as a way to provide some additional income. P2P can offer higher returns but can be risky if one invests in the wrong people. Unlike bonds, you’re giving your money to another person in the hope they pay you back. Right now the most popular P2P platform is Lending Club. Their average default rate is around 5%. This could change depending on the state of the economy. However, P2P companies created a line of screening tools and portfolio settings to help lower risk. The site also allows users to potentially hold 100s of different loans. Such investments are also short term and offer higher returns than the methods listed above. For instance, investors could earn 5-8% annually! That being said, P2P is a new form if investing. How P2P holds up during recessions is unclear.
Right now I have my cash holdings in a money market account. The interest is negligible but it’s something. I’m also in the process of reviewing a variety of bond funds. Again, bonds can be complex. The opportunity costs associated with rising interest rates makes investing in certain bonds risky. Overall, there are many forms of lower risk investments. When choosing, investors need to evaluate when they need the money (liquidity), the risk they are willing to take (credit rating, FDIC), and the potential returns.
DISCLAIMER: I am not a licensed investment advisor or tax professional. I am not liable for any losses incurred by any parties. This blog should be viewed for entertainment and/or educational purposes only. Any transactions published are not recommendations to buy or sell any securities. Please consult with an investment professional before making investment decisions.