Which Investment Type Typically Carries the Least Risk?

April 16, 2020 disrupt

Which investment type typically carries the least risk?

 

Investment Types

Investing over long periods of time is a near surefire way to create a dramatic financial shift. The question is, will you be creating a dramatic financial change in a positive or negative direction? This revolves around low-risk investments vs high-risk investments. First, we must compare the main differences and when it is strategic to use each one.

A low-risk investment is an investment with a proven history and track record to perform well over time, it hedges against market volatility, and due to its safety, there are usually lower returns as well.

A high-risk investment focuses more on the higher returns over a shorter period, and due to this, there is an inherent risk involved. These are usually risky investments that have a big payday or a financial sinkhole.

The cursory strategy of when to implement is largely balanced by an independent scale known as time horizon. Risk tolerance with respect to your time horizon is a great way to make educated decisions on when and where to invest your hard-earned money.

Which type of portfolio might a young investor who is not afraid of risk choose?

A young investor who is not afraid of high risk is largely founded upon the idea that he has a longer time horizon.

A young investor has the time to make mistake (although he sure doesn’t choose to purposefully) and still have time to correct if there were a financial fallout. This inherent risk could be worth taking solely because the higher risk has a higher reward.

This means that if he does hit, then the young investor would strike big! This would not be a wise strategy for an older gentleman with a shorter time horizon. At this stage of life, most should be looking for which investment has the least risk.

With a longer time horizon, we have the room to choose for a higher risk investment, whereas once our time horizon shortens then I would advise choosing an investment with a lower risk.

Volatile Investments

If an investment is considered “volatile”, it means that there are frequent swings in the market and less certainty regards its performance. Volatile investments usually have high peaks but also very low valleys.

A volatile investment is usually only recommended once a portfolio is established and looking for a surge to explode their investments. Volatile investments are not recommended as a first investment, without understanding all the intrinsic risks. The next most common question is what is a safe investment with high returns?

This is my opinion, but my favorite investment with high returns over long periods of time and a proven track record over decades is commercial real estate investing. Commercial real estate investing, specifically multifamily investing has proven over several decades to be a strong investment.

According to Andrew Carnegie, a billionaire investor “[over] ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.” There is a balance of just below medium risk and medium to high return on investment. This is the best return on investment over long periods of time.

This is one of the few examples that provides the possible returns of a high risk/volatile investment while still being considered a medium to low-risk investment.

Why is a high-quality bond typically considered as a lower-risk investment than a stock?

Bonds are typically a very low-risk investment due to the nature and structure of a bond. A bond is a debt vehicle used as a promise to pay back the investor with interest, whereas a stock is an equity vehicle used as a promise to pay back the investor through dividends.

Bonds have a guaranteed returned, however stocks are not guaranteed. Most investment portfolios should always have some percentage of high-quality bonds since that are usually very secure and there is usually a larger percentage of bonds in an investment portfolio as we approach retirement. A downside of bonds with respect to stocks is that they typically carry a lower return.

Again think, risk tolerance vs. time horizon. I have a slight bias against stocks for several reasons, however there is a small exception. I am all in favor for mutual funds and index funds.

If you must invest in the stock market, I would strongly recommend to research mutual funds and index funds first.

Mutual funds are a grouping of hand-picked stocks across multiple industries and investing in one mutual fund means you own a small percentage of each company. Index funds means you are investing in the entire index. These are both lower risk than investing in a single stock and crossing your fingers.

Which of the following would be considered the highest risk portfolio?

One last metric to consider is how liquid an investment is during its investment, which is another form of risk.

If an investment is liquid that means it can be pulled out at any point in time the investor chooses, however an illiquid investment is more difficult to convert back to cash.

Examples of illiquid investments would be ownership interests in a private company, art, antiques, shares in hedge funds, penny stocks, bonds, and real estate. This is caused from a supply and demand argument of how readily an asset can be converted to cash.

The question is real estate a liquid investment depends on the market, but generally it’s considered an illiquid investment which can be viewed as a positive aspect since it has proven strong positive returns over long periods of time in the commercial real estate industry.

Examples of liquid investments would be money market funds, shares of publicly held companies, a savings account, and gold. Choose the best investment for you based on your risk tolerance, time horizon, and liquidity.

One reason I chose commercial real estate is because of a famous quote by former U.S. president Franklin D. Roosevelt, “Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.”

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